Using the Capital Asset Pricing Model (CAPM), what is the estimated cost of equity capital if the risk-free rate is 3.3%, Beta is .90, and the market premium is 6.0%?

The Capital Asset Pricing Model (CAPM) is a widely-used method for estimating the cost of equity capital. It is based on the relationship between expected return and risk, as quantified by beta. The formula is given as:

Cost of equity = Risk-free rate + Beta x Market risk premium

Given the values in this scenario:

• The risk-free rate is 3.3%

• Beta is 0.90

• The market risk premium is 6.0%

Substituting these values into the CAPM formula gives:

Cost of equity = 3.3% + (0.90 x 6.0%)

First, calculate the product of Beta and the market risk premium:

0.90 x 6.0% = 5.4%

Next, add this to the risk-free rate:

Cost of equity = 3.3% + 5.4% = 8.7%

This calculation indicates that the estimated cost of equity capital, based on the provided risk-free rate, beta, and market risk premium, is 8.7%. This corresponds to the correct answer.

Understanding the context of these figures helps clarify their significance: the risk-free rate reflects the return on an investment with zero