Question

Suppose you must estimate the cost of equity for a firm, and you have the following data: rRF = 5.5%; rM – rRF = 6%; b = 0.8; D1 = $1.00; P0 = $25.00; g = 6%; and rd = the firm's bond yield = 6.5%. What is this firm's cost of equity using the bond-yield-+-risk-premium approach? Use a 4% judgmental risk premium in your calculation.

Answer 1

rd+premium = 10.5%

using CAPM = 10.3%

Step-by-step explanation:

Under bond-yield+ risk-premium approach

This method simply propose to add the bond yield with the estmated risk premium:

0.065 + 0.04 risk premium = 0.105

`Ke= r_f + \beta (r_m-r_f)\\\\Where:\\r_f =$ risk free rate\\r_m= $ market rate\\\beta =non-diversifiable \:risk`

r_f = 0.055

β = 0.8

(r_m-r_f) = 0.06

0.055 + 0.8(0.06) = 0.103 cost of capital using CAPM