ANSWER

Calculating a company’s cost of equity capital is a crucial step in financial analysis and decision-making, as it helps determine the minimum return that a company must generate to satisfy its shareholders. One widely used method to calculate the cost of equity is the Capital Asset Pricing Model (CAPM), which takes into account various factors including the risk-free rate, the stock’s beta, and the expected return on the market.

In this scenario, we are tasked with finding The Great Ltd’s cost of equity capital using the CAPM formula:

$RE=Rf+\text{betaE}\cdot (RM-Rf)$

Where:

• $RE$ represents the cost of equity capital.
• $Rf$ is the risk-free rate.
• $\text{betaE}$ is the beta of the company’s ordinary shares.
• $RM$ is the expected return on the market.

First, we are given the risk-free rate ($Rf$) of 4.0 percent and the expected return on the market ($RM$) of 11 percent. These values are essential in assessing the return that investors could expect from a risk-free investment and the overall market return.

The company’s beta ($\text{betaE}$) is provided as 1.5. Beta is a measure of a stock’s sensitivity to market movements. A beta of 1.0 indicates that the stock moves in line with the market, while a beta greater than 1.0 (as in this case) suggests the stock is more volatile than the market.

Now, let’s calculate The Great Ltd’s cost of equity capital using the CAPM formula:

$RE=0.04+1.5\cdot (0.11-0.04)$

First, calculate the difference between the expected market return ($RM$) and the risk-free rate ($Rf$):

$RM-Rf=0.11-0.04=0.07$

Now, multiply the beta ($\text{betaE}$) by this difference:

$1.5\cdot 0.07=0.105$

Finally, add this result to the risk-free rate ($Rf$) to find the cost of equity ($RE$):

$RE=0.04+0.105=0.145$

To express the cost of equity as a percentage, multiply by 100:

$RE=0.145\times 100=14.5\%$

So, The Great Ltd’s cost of equity capital is approximately 14.5 percent.

In conclusion, by utilizing the Capital Asset Pricing Model (CAPM), we have determined that The Great Ltd’s cost of equity capital is 14.5 percent. This percentage represents the minimum return required by investors to compensate for the company’s risk, as measured by its beta, in relation to the overall market and the risk-free rate. Accurate calculation of the cost of equity is fundamental for financial planning, valuation, and investment decision-making, as it helps assess the attractiveness of the company’s stock to potential investors.