calculation Problem 9

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November 2, 2015 at 7:17 pm #280133
ripon
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AJT co has a gearing ratio (debt: (equity + debt)) of 30% and pays corporation tax of 25%.
AJT has an assets (ungeared) beta of 1.2. The risk free rate is 5% and the market return is 12%.

What is the cost of equity for AJT?

A) 19.40%
B) 11.36%
C) 13.40%
D) 16.10%
November 3, 2015 at 6:49 am #280168
John Moffat
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For every 30 debt there is 70 equity

Using the asset beta formula, 1.2 = (70 / (70 + (0.75 x 30)) x equity beta
So equity beta = 1.586

So cost of equity = 5% + 1.586 (12% – 5%) = 16.10%
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