How do you calculate the cost of equity capital for Sergeant Company?

The cost of equity capital reflects the return that equity investors expect on their investment in a company. To calculate the cost of equity using the Capital Asset Pricing Model (CAPM), you start with the risk-free rate, which represents the return on an investment with no risk of financial loss.

Next, the equity investor's required return is adjusted based on the company's systematic risk, represented by beta. Beta measures the volatility of the company's stock relative to the market. The market premium is then added to reflect the additional return expected by investors for taking on the higher risk associated with investing in the stock market versus risk-free securities.

Thus, the calculation is structured as: the risk-free rate plus the product of beta and the market risk premium. This correctly accounts for both the time value of money through the risk-free rate and the additional risk associated with the equity investment.

The chosen answer effectively captures this logic, accurately reflecting the components required to determine the cost of equity capital in a straightforward formula aligned with financial principles. Other options may introduce unnecessary complexity or inaccurately combine the elements involved in the cost of equity calculation.