CMA Intermediate · Financial Management and Business Data Analytics · Cost of Capital
Kaveri Auto Ltd has a risk-free return of 7%, an expected market return of 13% and an equity beta of 1.2. Under the CAPM approach, what is its cost of equity?
The cost of equity is 14.2%. CAPM adds a risk premium to the risk-free rate: the market premium is 13% minus 7% = 6%, multiplied by beta of 1.2 gives 7.2%, and adding the 7% risk-free rate gives 14.2%.
- A14.2%Correct
- B15.6%
- C7.2%
- D13.0%
Explanation
Ke = Rf + beta x (Rm - Rf) = 7 + 1.2 x (13 - 7) = 7 + 7.2 = 14.2%. The 15.6% option wrongly uses beta x Rm (1.2 x 13). The 7.2% option omits the risk-free rate, and 13% ignores beta altogether.
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