Suppose that a foreign project has a beta of the risk?free return is 13% and the required return on the market is estimated at 21%.Then the cost of capital for the project is

Question

Quizplus · Accepted Answer

The cost of equity for the project is calculated using the Capital Asset Pricing Model (CAPM):

Cost of Equity = Risk-Free Rate + Beta*(Market Risk Premium)

Market Risk Premium = Required Return on the Market - Risk-Free Rate 
Market Risk Premium = 21% - 13% = 8%

Substituting the beta value in the formula,

Cost of Equity = 13% + 0.8*(8%) 
Cost of Equity = 19.4%

Assuming the project is financed with 100% equity, the cost of capital for the project is equal to the cost of equity.

Therefore, the cost of capital for the project is 19.4%, which is closest to option B (22.2%). Option A (24.2%) is too high and options C (19.3%) and D (15.4%) are too low.

Suppose That a Foreign Project Has a Beta of the Risk?free