All else constant, which one of the following will increase a company's cost of equity if the company computes that cost using the security market line approach? Assume the firm currently pays an annual dividend of $1 a share and has a beta of 1.2.
A) A reduction in the dividend amount
B) An increase in the dividend amount
C) A reduction in the market rate of return
D) A reduction in the firm's beta
E) A reduction in the risk-free rate

Question

Quizplus · Accepted Answer

The security market line approach to computing a company's cost of equity is based on the Capital Asset Pricing Model (CAPM), which is represented by the formula: Cost of Equity = Risk-Free Rate + Beta * (Market Rate of Return - Risk-Free Rate). A reduction in the risk-free rate decreases the starting point of this calculation, thereby increasing the cost of equity, as the expected return on a risk-free asset decreases, investors will demand a higher return on risky assets to compensate for the increased risk relative to the risk-free asset.

All Else Constant, Which One of the Following Will Increase