Jacque Ewing Drilling, Inc. has a beta of 1.3 and is trying to calculate its cost of equity capital. If the risk-free rate of return is 8 percent and the expected return on the market is 12 percent, then what is the firm's after-tax cost of equity capital if the firm's marginal tax rate is 40 percent

Firm's after-tax cost of equity capital = 13.2%

Explanation:

Cost of equity:

The cost of equity is the return that an investor expects to receive from an investment in a business. It is required to persuade an investor to make a given equity investment.

There isn't any need to calculate the after-tax cost separately because in our case of equity, the cost of after-tax and pre-tax is same.

Formula:

Cost of equity = risk-free rate + beta * (market return - risk-free rate)

where

The risk-free rate carries no risk or zero risk and is the return on an investment. Beta is the degree in which the company's equity returns change in comparison to the overall market. Market return includes all assets and is the return on the overall market portfolio.

As beta = 1.3

risk-free rate of return = 8%

Expected return on the market = 12 %

Therefore by putting the values to the formula, we get

Cost of equity = 8% + 1.3 * (12% - 8%)

Cost of equity = 13.2%