Skip to content

CMA Final · Strategic Performance Management and Business Valuation · Fundamentals of Business Valuation

Which statement about the cost of equity under the CAPM used in valuation is correct?

Under CAPM the cost of equity equals the risk-free rate plus beta multiplied by the equity market risk premium. Beta scales the market premium to the firm's systematic risk, so higher beta raises the required return used in discounting.

  1. AIt equals the risk-free rate plus beta multiplied by the equity market risk premiumCorrect
  2. BIt equals the risk-free rate plus the equity market risk premium divided by beta
  3. CIt equals beta multiplied by the risk-free rate
  4. DIt equals the after-tax cost of debt plus the market risk premium

Explanation

CAPM states Ke = Rf + beta x (Rm - Rf), where the bracket is the market risk premium. Other options misuse beta or substitute the cost of debt.

Did you get it right without looking?

One question tells you little. A timed set on Fundamentals of Business Valuation shows your real accuracy, how long you take and where you lose marks.

Practise Fundamentals of Business ValuationFree diagnostic mock

More Fundamentals of Business Valuation questions