A firm has a return on equity of 12.4 percent according to the dividend growth m

Question

A firm has a return on equity of 12.4 percent according to the dividend growth model and a return of 18.7 percent according to the capital asset pricing model. The market rate of return is 13.5 percent. What rate should the firm use as the cost of equity when computing the firm's weighted average cost of capital (WACC)?

A.

12.4 percent because it is lower than 18.7 percent

B.

18.7 percent because it is higher than 12.4 percent

C.

The arithmetic average of 12.4 percent and 18.7 percent

D.

The arithmetic average of 12.4 percent, 13.5 percent, and 18.7 percent

Explanation / Answer

For weighted average cost of capital, the cost of equity should be the average mean of the Cost of equity as per the dividend growth model and the market rate of return.

Hence, the correct option is

C.

The arithmetic average of 12.4 percent and 18.7 percent

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