Answer:
Cost of equity = 14.36%
Explanation:
The capital asset pricing model is a risk-based model. Here, the return on equity is dependent on the level of reaction of the the equity to changes in the return on a market portfolio. These changes are captured as systematic risk. The magnitude by which a stock is affected by systematic risk is measured by beta.
Under CAPM, Ke= Rf + β(Rm-Rf)
Rf-risk-free rate (treasury bill rate), β= Beta, Rm= Return on market.
The capital asset pricing models is adjudged to be superior to the dividend valuation model because incorporates risk into determining the investors' required rate of return.
Using this model,
Cost of equity = 3.5% + 1.22(12.4- 3.5)%
= 3.5 + 10.858
= 14.36%
Cost of equity = 14.36%
