Asked by Bhushan Chaudhari on Jun 26, 2024
Verified
Kirchner Exports has a beta of 1.2. The risk free rate is 5% and the return on an average stock is 10.6%. Estimate Kirchner's cost of retained earnings.
A) 10.60%
B) 11.72%
C) 12.72%
D) 13.72%
E) 16.60%
Cost of Retained Earnings
The opportunity cost for shareholders for having the company retain the earnings instead of distributing them, often considered in investment and dividend decisions.
Risk Free Rate
The theoretical rate of return of an investment with zero risk of financial loss, often represented by the yield on government bonds.
Beta
A measure of a stock's volatility in relation to the overall market; a beta greater than one indicates higher than market volatility.
- Estimate the cost of equity utilizing different methodologies including the dividend growth model and the Capital Asset Pricing Model (CAPM).
- Investigate the interplay between market risk (beta), the risk-free rate, and the market risk premium, and their role in determining a firm's cost of capital.
Verified Answer
EL
emily lojanoJun 30, 2024
Final Answer :
B
Explanation :
The cost of retained earnings can be estimated using the Capital Asset Pricing Model (CAPM), which is given by the formula: Cost of Equity = Risk-Free Rate + Beta * (Market Return - Risk-Free Rate). Plugging in the values: 5% + 1.2 * (10.6% - 5%) = 5% + 1.2 * 5.6% = 5% + 6.72% = 11.72%.
Learning Objectives
- Estimate the cost of equity utilizing different methodologies including the dividend growth model and the Capital Asset Pricing Model (CAPM).
- Investigate the interplay between market risk (beta), the risk-free rate, and the market risk premium, and their role in determining a firm's cost of capital.