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15 September, 10:52

Frank & Sons, a 100% equity financed firm, has a beta equal to 1.3. The firm's stock is currently trading at $25 per share, and pays a $1.50 per share dividend. Treasury securities are trading at prices that result in a 7% yield, while current projections claim a 15% return from the stock market. What is Frank & Sons' required rate of return on average risk projects?

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  1. 15 September, 14:00
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    The required rate of return on the risky projects is 17.40%

    Explanation:

    The required rate of return on average risky projects of Frank and Sons can be computed using the cost of equity formula below:

    Ke=Rf+beta * (Mr-Rf)

    Rf is the risk rate of return on government security which is 7%

    beta is the sensitivity of the project to market return is 1.3

    Mr is the market expected return which is 15%

    Ke=7%+1.3 * (15%-7%)

    Ke=7%+1.3*8%

    Ke=7%+10.4%

    Ke=17.40%

    The required rate of return on the risky projects is 17.40%
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