Question

NewLinePhone Corp. is very risky, with a beta equal to 2.8 and a standard deviation of returns of 32%. The risk-free rate of return is 3% and the return on the market is 11%. NewLinePhone's marginal tax rate is 35%. Use the capital asset pricing model to estimate NewLinePhone's cost of retained earnings. 19.7% 23.9% 22.1% 25.4%

Answer 1

Risk-free rate (Rf) = 3%

Market return (Rm) = 11%

Beta (β) = 2.8

Ke = Rf +β(Rm - Rf)

Ke = 3 + 2.8(11 - 3)

Ke = 3 + 2.8(8)

Ke = 3 + 22.4

Ke = 25.4%

Step-by-step explanation:

Cost of retained earnings is a function of risk-free rate plus beta multiplied by risk-premium. Risk premium is the difference between market return and risk-free rate,