A company wants to determine the cost of equity to use in calculating its
weighted average cost of capital. The controller has gathered the following
information:
Rate of return on 3-month Treasury bills = 3%
Rate of return on 10-year Treasury bonds = 3.5%
Market equity risk premium = 6.0%
The company�s estimated beta = 1.6
The company�s after-tax cost of debt = 8.0%
Risk premium of equity over debt = 4.0%
Corporate tax rate = 35%
Using the capital asset pricing model (CAPM) approach, the cost of equity (%)
for the company is closest to:
A. 7.5.
B. 12.6.
C. 13.1.
Answer: C
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Why do we use the rate of return on the 10yr t-bond of 3.5% rather than the 3month t-bill of 3.0% as the risk free rate? Should we always use the highest return on risk free investments as the RFR?
Thanks for all the help!
(Question taken from CFAI mock, #73 morning.)
weighted average cost of capital. The controller has gathered the following
information:
Rate of return on 3-month Treasury bills = 3%
Rate of return on 10-year Treasury bonds = 3.5%
Market equity risk premium = 6.0%
The company�s estimated beta = 1.6
The company�s after-tax cost of debt = 8.0%
Risk premium of equity over debt = 4.0%
Corporate tax rate = 35%
Using the capital asset pricing model (CAPM) approach, the cost of equity (%)
for the company is closest to:
A. 7.5.
B. 12.6.
C. 13.1.
Answer: C
----------------------------------------
Why do we use the rate of return on the 10yr t-bond of 3.5% rather than the 3month t-bill of 3.0% as the risk free rate? Should we always use the highest return on risk free investments as the RFR?
Thanks for all the help!
(Question taken from CFAI mock, #73 morning.)