Booher Book Stores has a beta of 0.5. The yield on a 3-month T-bill is 5% and the yield on a 10-year T-bond is 7%.

FIN - 650 --- Problem 9-06 (Cost of Equity: CAPM)

Booher Book Stores has a beta of 0.5. The yield on a 3-month T-bill is 5% and the yield on a 10-year T-bond is 7%. The market risk premium is 4.5%, and the return on an average stock in the market last year was 14%. What is the estimated cost of common equity using the CAPM? Round your answer to two decimal places.

________%

Solutions

Expert Solution

Beta = 0.5

We need to use the 10-year T-bond rate as the risk free rate because the projects are of long term. We should not use the 3-month t bill rate as the risk-free rate

rf = 7%

Market risk premium = 4.5%

rm - rf = 4.5%

CAPM

r_e = r_f + β * (r_m - r_f)

r_e = 0.07 + 0.5 * 0.045

r_e = 0.07 + 0.0225

r_e = 0.0925

r_e = 9.25%

The estimated cost of common equity using the CAPM is 9.25%

jeff jeffy answered 2 years ago

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