Cost of Retained Earnings: CAPM Approach

Cost of Retained Earnings

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Question

Consider the following information:

30 day T-Bill rate (Risk free rate) 7.2%

Common Stock Beta 0.8 -

Expected Rate of return for the market 15.0%

Net Worth to Total Asset Multiple .25

Calculate this firm's cost of retained earnings using the CAPM approach.

Answers

Explanations

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Explanation

To calculate the cost of retained earnings for a firm using CAPM, one may use the following formula: Cost of retained earnings = risk free rate + ((expected rate of return on the market - risk free rate) x Beta). In this case the cost of retained earnings = 7.2% + ((15.0% - 7.2%) x 0.8 = 13.44%.

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