Question

Company A has a beta of 0.70, while Company B's beta is 1.45. The required return on the stock market is 11.00%, and the risk-free rate is 4.25%. What is the difference between A's and B's required rates of return? (Hint: First find the market risk premium, then find the required returns on the stocks.) Do not round your intermediate calculations.

Answer 1

Answer:

company B's cost of equity is 14.0375% - 8.975% = 5.0625% higher than company A's cost of equity

Explanation:

cost of equity = risk free rate + (beta x market premium)

risk free rate = 4.25%

market premium = market return - risk free rate = 11% - 4.25% = 6.75%

Company A's cost of equity = 4.25% + (0.7 x 6.75%) = 8.975%

Company B's cost of equity = 4.25% x (1.45 x 6.75%) = 14.0375%

this means that company B's cost of equity is 14.0375% - 8.975% = 5.0625% higher than company A's cost of equity.