Question

what is the cost of equity using the capital asset pricing model if the risk free rate is 4.5%, the beta is 1.75 and the equity risk premium is 4.25%?

Answer 1

The cost of equity is a term used in finance to describe the return (usually expressed as a rate of return) that a firm theoretically offers to its equity investors, or shareholders, in order to make up for the risk they assume by investing their money. A firm needs cash from various sources in order to operate and grow. Those individuals and organizations who are willing to offer money to others naturally desire payment. Just as landlords want rent for their homes, capital providers seek returns on their investments that must be proportional to the level of risk involved.

Given :

Risk free rate = 4.5%

Beta = 1.75

Equity risk premium= 4.25%

To find :

Cost of equity

Solution :

Cost of equity is given by,

=Risk-Free Rate of Return + Beta × (Equity risk premium)

= 4.5+1.75×(4.25)

=4.5+7.4375

=11.9375%

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