The common stock of Kansas City Power and Light has a beta of 0.80. The Treasury bill rate is 4 percent and the market risk premium is 8 percent. KCP&L is in the 34% tax bracket. What is their cost of equity capital?

Question

Quizplus · Accepted Answer

Using the capital asset pricing model (CAPM), we can calculate the cost of equity as follows:

Cost of Equity = Risk-Free Rate + Beta * Market Risk Premium
Cost of Equity = 4% + 0.80 * 8%
Cost of Equity = 4% + 6.4%
Cost of Equity = 10.4%

However, since KCP&L is in the 34% tax bracket, we need to adjust the cost of equity for taxes using the following formula:

Cost of Equity (After Tax) = Cost of Equity (Before Tax) * (1 - Tax Rate)
Cost of Equity (After Tax) = 10.4% * (1 - 0.34)
Cost of Equity (After Tax) = 6.86%

Therefore, the closest answer choice is B, which is 10.4%.

The Common Stock of Kansas City Power and Light Has