The risk-free rate of return is 2% and the expected return on the market portfolio is 8%. 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 common stock

Question

Alex Bradley

Business

13 September, 03:19

The risk-free rate of return is 2% and the expected return on the market portfolio is 8%. 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 common stock

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Answers (1)

Know the Answer?

Maria Lamb · Answer 1

The multiple choices are as follows:

18.6%

14.0%

22.8%

25.0%

The second option is the correct answer, 14%

Explanation:

The capital asset pricing asset model formula for computing a firm's cost of equity according to Miller and Modgiliani is given below:

Ke=Rf+Beta * (Mr-Rf)

Rf is the risk free of 2% which is the return expected from zero risk investment such as government treasury bills.

Beta is how risky an investment in a company is compared to similar businesses operating in similar business sector of the company given as 2.0

Mr is the expected return on market portfolio which 8%

Ke=2%+2 * (8%-2%)

Ke=2%+2 * (6%)

Ke=2%+12%=14%