or debt annual payments of 580 on S1,000 boi a 5. The cost of equity. The divide

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or debt annual payments of 580 on S1,000 boi a 5. The cost of equity. The dividend of Onogo Inc. is currently $2 per share and is supposed to grow percent a year forever. Its share price is $50. Its beta is 1.08. The market risk mium is 5 percent and the risk-free rate is 4 percent. What is your best estimate Onogo's cost of equity? Practical application of the capital asset pricing model. According to the capital asset pricing model: where E(R), the expected return on security i, is the sum of Rp, the return on a risk free investment, and [E(RW-R/ s the expected extra return over the risk-free for taking on the risk of holding the security. , measures the relative sensitivity of the security's returns to changes in the return of a market index. E(R) is the expected return on a market index, andE(RM)-RF] is the difference between the expected market return and the ris-free rate, otherwise known as the market risk premium. In recent years, there has been considerable debate about the size of the market k premium. Most textbooks, including this one, give a range between 4 percent and 6 percent. However, some of the major investment banks are using a market risk ium as low as 3 percent when they are computing the cost of capital for valuing ris prem a company in mergers or other transactions. How coul ld rates as low as 3 percent be justified? What are the possible argu- ments used by the banks? If you were buying another company, would you agree to such a low rate? What if you were the selling firm? 7. Calculating the weighted average cost of capital. Suppose that Tale Inc. has the following target capital structure: 50 persent stogk

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D0 2 g 5% P0 50 Rp 5% Rf 4% Beta 1.08 Cost of equity as CAPM method=Rf+Beta*(Rp) =4%+1.08*(5%) 9.40% Cost of equity from Dividend Growth model=D0*(1+g)/P0+g =2*(1.05)/50+0.05 9.20% Best possible estimate is average of cost of equity under both method So Cost of equity=(9.4%+9.2%)/2 9.30%

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