CA Intermediate · Financial Management and Strategic Management · Cost of Capital
Sundaram Engineering Ltd's equity share has a beta of 1.2. The risk-free return is 7% and the expected market return is 12%. Using CAPM, what is the cost of equity?
The cost of equity is 13%. Under CAPM, the market risk premium is 12% minus 7%, which is 5%. Multiplying by beta of 1.2 gives 6%, and adding the 7% risk-free return gives 13%.
- A13.0%Correct
- B12.0%
- C6.0%
- D15.4%
Explanation
Ke = Rf + β(Rm - Rf) = 7 + 1.2 × (12 - 7) = 7 + 6 = 13%. 12% would apply if beta were 1. 6% is just the risk premium component (β × market premium). 15.4% wrongly computes 1.2 × 12 + 1... mixing the market return with beta instead of the premium.
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