Question

Q Your firm is planning to invest in a new power generation system. Galt Industries is an all equity firm that specializes in this business. Suppose Galt's equity beta is 0.75, the risk-free rate is 3%, and the market risk premium is 6%. If your firm's project is all equity financed, then your estimate of your cost of capital is closest to:
5.25%
6.00%
6.75%
7.50%
select any one option ​

Answer 1

Answer: Option A - 5.25%

Explanation

E(Ri) = Rf + βi * [E(Rm) – Rf] * 100

        = 0.03 + 0.75 (0.06 - 0.03) * 100

        = 5.25%

     

Answer 2

Given:

Equity Beta = 0.75

Risk free rate = 3%

Market risk premium = 6%

To find:

The estimate of Cost of Capital

Solution:

Risk free rate = 3% = 0.03

Market risk premium = 6% = 0.06

As per the formula -

E(Ri) = Rf + βi * [E(Rm) – Rf]

Substituting the values -

= 0.03 + 0.75 (0.06)

= .075

Calculating in perecentage -

= 0.75 x 100

= 7.5%

Answer: The estimate cost of capital is 7.5%