The Delta Co. owns retail stores that market home building supplies. Largo, Inc. builds single family homes in residential developments. Delta has a beta of 1.22 and Largo has a beta of 1.34. The riskminus free rate of return is 4 percent and the market risk premium is 6.5 percent. What should Delta use as their cost of equity if they decide to purchase some land and create a new residential community?

Question

Business

Oompa Loompa

10 June, 21:25

The Delta Co. owns retail stores that market home building supplies. Largo, Inc. builds single family homes in residential developments. Delta has a beta of 1.22 and Largo has a beta of 1.34. The riskminus free rate of return is 4 percent and the market risk premium is 6.5 percent. What should Delta use as their cost of equity if they decide to purchase some land and create a new residential community?

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Answers (1)

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Jake Mahoney · Answer 1

12.71%

Explanation:

In this question, we apply the Capital Asset Pricing Model (CAPM) formula which is shown below

Expected rate of return = Risk-free rate of return + Beta * (Market rate of return - Risk-free rate of return)

= 4% + 1.34 * 6.5%

= 4% + 8.71%

= 12.71%

The (Market rate of return - Risk-free rate of return) is also called market risk premium and the same is used in the computation part. We ignored the bets of Delta