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Homework answers / question archive / You are analyzing a company and determine it has a beta of 17 If everything else remains constant, the cost of equity for this company will increase if the Multiple Choice O market rnik premium decreasen nuk free rate decreases The nisk-free rate and the market rate of retum decrease risk-free rate decreases The risk free rate and the market rate of return decrease
You are analyzing a company and determine it has a beta of 17 If everything else remains constant, the cost of equity for this company will increase if the Multiple Choice O market rnik premium decreasen nuk free rate decreases The nisk-free rate and the market rate of retum decrease
risk-free rate decreases The risk free rate and the market rate of return decrease. beta decreases market rate of return decreases
Ans) risk free rate decreases
As per CAPM , cost of equity = Risk free rate of return + beta(Market return - risk free rate of return)
Now if risk free rate of return , decreased value of risk premium will increase and since beta is greater than 1 , reduction in risk free rate will be covered.
For example let's say risk free rate opf return is 5% , beta = 1.7 and market return = 15%
Cost of equity = 5% + 1.7(15%-5%)
= 5% + 1.7(10%)
= 5 + 17%
=22%
now if risk free rate decreases to 3% , then
cost of equity = 3% + 1.7(15%-3%)
= 3% + 1.7(12%)
= 3 + 20.4%
=23.4%
