Reference no: EM132768925

Problem 1: Smith Brothers is a small company and it isn't publicly traded, but Christine wants to make sure that she understands the appropriate cost of equity to be used for her new company. When evaluating the three divisions, she found 5 publicly traded companies for the pure play method and the average beta was 1.44. She wants to determine the expected return on the market and believes there is a 25% probability of a recession when stocks are likely to lose 4%, a 50% chance of a normal economy when stocks will earn 10%, and a 25% probability that the economy will boom and earn 16%. The risk-free rate is 2.2 percent. What is the cost of equity after using the CAPM and adding 6% for the small equity size premium?

Group of answer choices

Option 1: 19.43%

Option 2: 16.55%

Option 3: 16.38%

Option 4: 10.44%

Option 5: 16.92%

Option 5: 16.32%

Option 6: 10.55%