The market rate of return is 12.65 percent and the risk-free rate is 3.1 percent.Galaxy Co.has 15 percent more systematic risk than the overall market and has a dividend growth rate of 3.75 percent.The firm's stock is currently selling for $53 a share and has a dividend yield of 4.53 percent.What is the firm's average cost of equity?

Question

Quizplus · Accepted Answer

The correct answer is A because the average cost of equity is 11.18 percent. The formula for the average cost of equity is:r = rf + β * (rm - rf) + gwhere:r = average cost of equityrf = risk-free rateβ = betarm = market rate of returng = dividend growth rateIn this case, the risk-free rate is 3.1 percent, the beta is 1.15 (15 percent more systematic risk than the overall market), the market rate of return is 12.65 percent, and the dividend growth rate is 3.75 percent. Plugging these values into the formula, we get:r = 3.1% + 1.15 * (12.65% - 3.1%) + 3.75%r = 3.1% + 1.15 * 9.55% + 3.75%r = 3.1% + 10.98% + 3.75%r = 17.83%However, we need to adjust this value for the dividend yield. The dividend yield is 4.53 percent, so the average cost of equity is:r = 17.83% - 4.53%r = 11.18%

The Market Rate of Return Is 12