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3 August, 09:00

The risk-free rate of return is 2% and the expected return on the market portfolio is 8%. Oklahoma Oilco has a beta of 2.0 and a standard deviation of returns of 26%. Oilco's marginal tax rate is 35%. Analysts expect Oilco's net income to grow by 12% per year for the next 5 years. Using the capital asset pricing model, what is Oklahoma Oilco's cost of common stock

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  1. 3 August, 10:45
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    The multiple choices are as follows:

    18.6%

    14.0%

    22.8%

    25.0%

    The second option is the correct answer, 14%

    Explanation:

    The capital asset pricing asset model formula for computing a firm's cost of equity according to Miller and Modgiliani is given below:

    Ke=Rf+Beta * (Mr-Rf)

    Rf is the risk free of 2% which is the return expected from zero risk investment such as government treasury bills.

    Beta is how risky an investment in a company is compared to similar businesses operating in similar business sector of the company given as 2.0

    Mr is the expected return on market portfolio which 8%

    Ke=2%+2 * (8%-2%)

    Ke=2%+2 * (6%)

    Ke=2%+12%=14%
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