Question

The current risk-free rate of return (rRF) is 4.67% while the market risk premium is 6.17%. The Monroe Company has a beta of 0.92. Using the capital asset pricing model (CAPM) approach, Monroe's cost of equity is___.

The cost of equity using the bond yield plus risk premium approach. The Adams Company is closely held and, therefore, cannot generate reliable inputs with which to use the CAPM method for estimating a company's cost of internal equity. Adams's bonds yield 10.28%, and the firm's analysts estimate that the firm's risk premium on its stock over its bonds is 4. Based on the bond-yield-plus-risk-premium approach, Adams's cost of internal equity is:
a) 16.75%
b) 15.23%
c) 18.28%
d) 14.47%

Answer 1

The cost of equity using the CAPM approach is 10.34% for Monroe Company and the cost of equity using the Bond Yield Plus Risk Premium approach is 14.28% for Adams Company.

Step-by-step explanation:

The cost of equity using the Capital Asset Pricing Model (CAPM) approach is calculated by using the formula: Cost of Equity = Risk-Free Rate + (Beta * Market Risk Premium). Given that the risk-free rate of return (rRF) is 4.67%, the market risk premium is 6.17%, and Monroe Company's beta is 0.92, we can calculate Monroe's cost of equity as follows:

The cost of equity using the Bond Yield Plus Risk Premium approach is calculated by adding the bond yield to the firm's risk premium on its stock. Given that Adams Company's bonds yield 10.28% and the firm's risk premium on its stock over its bonds is 4, we can calculate Adams's cost of internal equity as follows: