CA Intermediate · Financial Management and Strategic Management · Cost of Capital
Anand Engineering Ltd's equity beta is 1.2, the risk-free rate is 7% and the expected market return is 12%. Using CAPM, what is the cost of equity?
The cost of equity is 13%. CAPM adds a risk premium to the risk-free rate: the market premium is 12% minus 7%, which is 5%, multiplied by beta 1.2 to give 6%. Adding the 7% risk-free rate gives 13%.
- A12.0%
- B13.0%Correct
- C14.4%
- D8.4%
Explanation
Ke = Rf + β(Rm - Rf) = 7 + 1.2 x (12 - 7) = 7 + 6 = 13%. 14.4% results from multiplying beta by the market return (1.2 x 12) instead of the premium. 12% ignores beta altogether.
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