a. What is the estimated beta coefficient of your company? What does this beta m
ID: 2668570 • Letter: A
Question
a. What is the estimated beta coefficient of your company? What does this beta mean in terms of your choice to include this company in your overall portfolio? (the beta is 0.34)
b. Given the beta of your company, the present yield to maturity on U.S. government bonds maturing in one year (currently about 4.5% annually) and an assessment that the market risk premium (that is - the difference between the expected rate of return on the 'market portfolio' and the risk-free rate of interest) is 6.5%, use the CAPM equation in order to find out what is the present 'cost of equity' of your company? Explain what is the meaning of the 'cost of equity'.
Explanation / Answer
Beta coefficient is measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the market as a whole. Beta is used in the capital asset pricing model (CAPM), a model that calculates the expected return of an asset based on its beta and expected market returns
The cost of equity is the return a firm theoretically pays to its equity investors, i.e.,shareholders, to compensate for the risk they undertake by investing their capital. Firms need to acquire capital from others to operate and grow. Individuals and organizations who are willing to provide their funds to others naturally desire to be rewarded. Just as landlords seek rents on their property, capital providers seek returns on their funds, which must be commensurate with the risk undertaken.
cost of equity =4.5 +0.34*6.5 =6.71%
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