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Forums › Ask ACCA Tutor Forums › Ask the Tutor ACCA FM Exams › Cost of equity – Ke
Hi,
I wondered whether someone can help me with the following.
A share in MS Co has an equity beta of 1.3. MS Co’s debt beta is 0.1. It has a gearing ratio of 20% (Debt:Equity). The market premium is 8% and the risk-free rate is 3%. MS Co pays 30% corp tax.
What is the cost of equity for MS Co?
My answer:
Ke = Rf + B (E (rm) – Rf)
= 3 + 1.3*(8% – 3%)
= 9.5%
BPP’s answer
Ke = Rf + B (E (rm) – Rf)
= 3 + (1.3*8%)
= 13.4%
Do you know why:
1) The brackets have been moved from 3+1.3( to 3+(1.3* … The formula says that the Beta should be added to the risk-free rate, however in this answer the Beta is being multiplied by the market return rate instead
2) The risk free rate isn’t being subtracted as per the formula?
Thanks
Simone
The premium is Market Return – Risk Free Rate already calculated
so premium = ( RM – RF)
The answer is
3 + sum of (8) * 1.3
or
3 + sum of 1.3(8)
or
3 + (1.3 * 8 )