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CA Intermediate · Financial Management and Strategic Management · Cost of Capital

Rohan Foods Ltd's equity share has a beta of 1.2. The risk-free return is 7% and the expected market return is 12%. Using the CAPM, the cost of equity is:

Under CAPM, cost of equity equals the risk-free rate plus beta times the market risk premium. The premium is 12% minus 7%, which is 5%; multiplied by 1.2 it gives 6%. Adding the 7% risk-free rate, the cost of equity is 13%.

  1. A13.00%Correct
  2. B14.40%
  3. C12.00%
  4. D8.40%

Explanation

Ke = Rf + β(Rm - Rf) = 7% + 1.2 × (12% - 7%) = 7% + 6% = 13%. Using Rf + β × Rm gives 14.4%, which wrongly applies beta to the whole market return rather than the premium. Check: premium 5% × 1.2 = 6%, plus 7% = 13%.

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