CFA Level I · CFA Level I Exam · The Capital Asset Pricing Model, Market Model, and Other Factor-Based Equity Models
An analyst estimates a stock's cost of equity using the capital asset pricing model. The risk-free rate is 3.0%, the equity risk premium is 5.5%, and the stock's beta is 1.20. The cost of equity is closest to:
The cost of equity is about 9.6%. Under CAPM it equals the risk-free rate plus beta times the equity risk premium: 3.0% plus 1.20 multiplied by 5.5%, which is 6.6%, giving 9.6%.
- A8.5%
- B9.6%Correct
- C10.2%
Explanation
CAPM: 3.0% + 1.20 × 5.5% = 3.0% + 6.6% = 9.6%. Choice 8.5% is 3.0% + 5.5%, which ignores beta. Choice 10.2% adds the beta-scaled premium to a wrong base, such as 3.6%.
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