Question

Jacque Ewing Drilling, Inc. has a beta of 1.3 and is trying to calculate its cost of equity capital. If the risk-free rate of return is 8 percent and the expected return on the market is 12 percent, then what is the firm's after-tax cost of equity capital if the firm's marginal tax rate is 40 percent

Answer 1

Answer:

Firm's after-tax cost of equity capital = 13.2%

Explanation:

Cost of equity:

The cost of equity is the return that an investor expects to receive from an investment in a business. It is required to persuade an investor to make a given equity investment.

There isn't any need to calculate the after-tax cost separately because in our case of equity, the cost of after-tax and pre-tax is same.

Formula:

Cost of equity = risk-free rate + beta * ( market return - risk-free rate )

where

• The risk-free rate carries no risk or zero risk and is the return on an investment.
• Beta is the degree in which the company's equity returns change in comparison to the overall market.
• Market return includes all assets and is the return on the overall market portfolio.

As beta = 1.3

risk-free rate of return = 8%

Expected return on the market = 12 %

Therefore by putting the values to the formula, we get

Cost of equity = 8% + 1.3 * ( 12% - 8% )

Cost of equity = 13.2%