The Sugar Cookie Company just paid its annual dividend of $.45 a share. The stock has a market price of $21 and a beta of. 88. The return on Treasury bills is 4.2 % and the market has an 11.8 % rate of return. What is the cost of equity for the Cookie Company?

The cost of equity based on the CAPM is 10.888%

Explanation:

The cost of equity of the stock or the required rate of return (r) is the minimum return required by investors to invest in a stock. The CAPM approach provides an equation to calculate the required rate of return (r) based on the risk free rate, stock's beta and the market risk premium. The formula for r is,

r = rRF + Beta * (rM - rRF)

Where,

rRF is the risk free rate or rate on T bills rM is the expected return on market

r = 0.042 + 0.88 * (0.118 - 0.042)

r = 0.10888 or 10.888%

Cost of equity is 10.9%

Explanation:

Cost Asset Pricing model will be used for the calculations of cost of equity.

Capital asset pricing model measure the expected return on an asset or investment. It is used to make decision for addition of specific investment in a well diversified portfolio.

In this Question the 4.2% of return on Treasury is Risk free rate, market return is 11.8% ans associated beta is 0.88.

Formula for CAPM

Expected return = Risk free rate + beta (Market return - Risk free rate)

Expected return = 4.2% + 0.88 (11.8% - 4.2%)

Expected return = 4.2% + 6.688%

Expected return = 10.888% = 10.9%