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Calculating cost of equity and expected rate of return

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If I have a company whose beta is .54,the present yield to maturity on U.S. government bonds maturing in one year (currently about 4.5% annually) and an assessment that the market risk premium is 6.5%, using the CAPM equation,what is the present cost of equity of my company?

If I have 2 companies, A and B, the beta of A is .50, the beta of B is .23, if I invest 1/3 of my money in each of the stocks of these companies, What will the beta of the portfolio be? If I add my other stock with a beta of .54, what would be the expected rate of return on this portfolio be? Is this 3-stock portfolio well diversified,or does it still have risk that can be diversified away?

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Solution Summary

Solution describes the use of CAPM model to calculate cost of equity a particular stock. It also explains the steps in calculating beta and expected rate of return of a portfolio.

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Solution :

1)
Beta = 0.54
Risk Free Rate of return Rf = 4.5%
Market Risk Premium = km-Rf = 6.5%

Required Rate of Return is given by
Kj = Rf +Beta*(Km-Rf)
= 4.5% +0.54*(6.5%)
=8.01%

Cost of equity will be 8.01%

2)
Beta (A) = 0.50
Beta ...

Solution provided by:
Lokesh Jain, MSc
Education
  • BEng (Hons) , Birla Institute of Technology and Science, India
  • MSc (Hons) , Birla Institute of Technology and Science, India
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