The risk-free rate of return is 3% and the expected return on the market portfolio is 14%. Oklahoma Oilco has a beta of 2.0 and a standard deviation of returns of 26%. Oilco's marginal tax rate is 35%. Analysts expect Oilco's net income to grow by 12% per year for the next 5 years. Using the capital asset pricing model, what is Oklahoma Oilco's cost of retained earnings? A) 25.0% B) 22.8% C) 21.2% D) 18.6%

Question

Eliza Frye

Business

30 December, 00:17

The risk-free rate of return is 3% and the expected return on the market portfolio is 14%. Oklahoma Oilco has a beta of 2.0 and a standard deviation of returns of 26%. Oilco's marginal tax rate is 35%. Analysts expect Oilco's net income to grow by 12% per year for the next 5 years. Using the capital asset pricing model, what is Oklahoma Oilco's cost of retained earnings? A) 25.0% B) 22.8% C) 21.2% D) 18.6%

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Sylvia Kent · Answer 1

25%

Explanation:

Data provided

Risk free return = 3%

Beta = 2

Expected return on the market portfolio = 14%

Risk-free rate of return = 3%

The computation of cost of retained earnings is shown below:-

Cost of retained earnings = Risk free return + Beta * Risk premium

= 3% + 2 * (14% - 3%)

= 3% + 2 * 11%

= 3% + 0.22

= 25%

Therefore, for computing the cost of retained earning we simply applied the above formula.