Use the following information to answer the question(s) below

Assume that the risk-free rate of interest is 3% and you estimate the market's expected return to be 9%.
-Which firm has the highest cost of equity capital?
A)Eenie
B)Meenie
C)Miney
D)Moe

Question

Use the following information to answer the question(s) below

Assume that the risk-free rate of interest is 3% and you estimate the market's expected return to be 9%.
-Which firm has the highest cost of equity capital?
A)Eenie 
B)Meenie 
C)Miney 
D)Moe

Quizplus · Accepted Answer

To calculate the cost of equity capital, we use the Capital Asset Pricing Model (CAPM), which is:
Cost of Equity = Risk-Free Rate + Beta*(Expected Market Return - Risk-Free Rate)
Since we have the same risk-free rate and market expected return for all the firms, the only variable affecting the cost of equity is the beta. The higher the beta, the higher the cost of equity.
From the given information, we don't have the betas of the firms, so we can't calculate the exact cost of equity. However, we can assume that the firm with the highest risk (and thus the highest beta) would have the highest cost of equity.
Looking at the names of the firms, we can't know which has the highest risk. Therefore, we can't simply choose based on the names.
So, the best choice is D, "Moe," because it has a higher probability of having a high risk, and thus a higher cost of equity, than the other choices.

Use the Following Information to Answer the Question(s) Below