Question
1.Bay-of-Islands Dairies Ltd has an interest cost of debt of 6 per cent per annum. The systematic risk of its equity is 1.2, and the
1.Bay-of-Islands Dairies Ltd has an interest cost of debt of 6 per cent per annum. The systematic risk of its equity is 1.2, and the effective company tax rate is 0.12. Forty per cent of its funding is provided by debt, while 60 per cent is provided by equity. The risk-free interest rate is 5 per cent per annum. In calculating its cost of capital, Bay-of-Islands has obtained two expert opinions as to the market risk premium (including the franking premium). One expert suggests that the market risk premium is 1 per cent per annum, while the other suggests that the market risk premium is 5 per cent per annum. What is Bay-of-Islands' cost of capital based on these experts' opinions of the market risk premium?
The answer to it being 1% is 6.2% & when 5% ke = 11%! However, after trying to calculate with the CAPM formula i cannot get this answer! A step by step process would be appreciated
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