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CMA Intermediate · Financial Management and Business Data Analytics · Cost of Capital

Which statement about the cost of equity share capital is correct under the CAPM approach?

Under CAPM, the cost of equity rises when beta rises, with other inputs unchanged. The formula is risk-free rate plus beta times the market risk premium, so a larger beta multiplies the premium and increases the return shareholders require.

  1. AIt rises when the equity beta rises, other inputs being unchangedCorrect
  2. BIt falls when the market risk premium rises
  3. CIt is unaffected by the risk-free rate
  4. DIt equals the dividend yield of the share

Explanation

Ke = Rf + beta x market premium, so a higher beta increases the required return when other inputs are constant. A higher market premium raises Ke for a beta above zero, a higher Rf raises Ke, and dividend yield alone is only one component of the growth model, not CAPM.

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