When to use treasury bond rate and treasury bill rate as risk free rate!!!

[archived_user]

A company wants to determine the cost of equity to use in calculating WACC.
rate of return on 3month treasury bill = 3.0%
rate of return on 10yr treasury bond = 3.5%
market equity risk premium = 6.0%
company’s estimated beta = 1.6
company’s after-tax cost of debt = 8.0%
risk premium of equity over debt = 4.0%
corporate tax = 3.5%
using CAPM approach, the cost of equity is closest to?
a. 7.5. B. 12.6. C. 13.1
SOLUTION:
3.5 + 1.6x (6) = 13.1%
source: 2010 cfa mock
WHY DIDNT THEY USE 3% AS THE RISK FREE RATE???

 

[archived_user]

Because it is better to use return on 10yr treasury bond as the risk free rate

 

[archived_user]

Solution should be 3.5 + 1.6 * 6 = 13.1

 

[archived_user]

Yh my bad. Typo

 

[archived_user]

Why? That’s what I want to know

 

[archived_user]

Probably because an equity investment is (generally) considered a long-term investment, so a long-term risk-free rate is more appropriate (more in line with the investment objectives) than a short-term rate.
That’s the reasoning I’d use. I don’t know if that’s what CFA Institute thinks.

 

[archived_user]

Thanks. Makes sense.