An analyst has collected data about Devers Co. and a world market index. The index implies an equity risk premium of 5 percent, and Devers has a beta of 1.2 with respect to the index. When the residuals from the beta regression are collected and included in the regression model as an additional factor, a segmented market risk premium of 13 percent is calculated and the segmented beta with respect to this factor is 0.8. The appropriate risk-free return is 4 percent. If Devers is estimating the cost of common equity for subsidiaries in developed, integrated foreign markets, what is the appropriate cost of common equity?
A) 10.0%
B) 12.1%
C) 16.8%
D) 18.3%
E) 20.4%

Question

Quizplus · Accepted Answer

The appropriate cost of common equity is 10.0%. This is calculated using the following formula:Cost of common equity = Risk-free return + Beta * Equity risk premium + Segmented market risk premium * Segmented beta= 4% + 1.2 * 5% + 0.8 * 13%= 4% + 6% + 10.4%= 10.0%

An Analyst Has Collected Data About Devers Co