Calculating Cost of Equity. Bohannon Corporation's common stock has a beta of 1.10. If the risk-free rate is 4.5% and the expected return on the market is 12%, what is the company's cost of equity capital?
R = Rf + (Rm - Rf)*B
= 4.5% + (12% - 4.5%)*1.10
= 4.5% + 7.5%*1.1
= 4.5% + 8.25%
= 12.75%
Cost of equity = 12.75%
To calculate the cost of equity, we can use the Capital Asset Pricing Model (CAPM) formula:
Cost of Equity = Risk-Free Rate + Beta * (Expected Return on the Market - Risk-Free Rate)
Let's plug in the given values:
Risk-Free Rate = 4.5%
Beta = 1.10
Expected Return on the Market = 12%
Using the CAPM formula, we can calculate:
Cost of Equity = 4.5% + 1.10 * (12% - 4.5%)
First, we calculate the difference between the expected return on the market and the risk-free rate:
12% - 4.5% = 7.5%
Next, multiply this difference by the beta:
1.10 * 7.5% = 8.25%
Finally, add the risk-free rate to the result:
4.5% + 8.25% = 12.75%
Therefore, the company's cost of equity capital is 12.75%.