CFIN
CFIN
5th Edition
ISBN: 9781305661639
Author: Scott Besley, Eugene Brigham
Publisher: Cengage Learning
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Chapter 8, Problem 15PROB
Summary Introduction

Capital asset pricing model (CAPM) is one of the methods used to calculate the cost of equity which show the relationship between expected return and risk of an investment. It describes that the expected return of the security is equal to the sum of rate of return of an investment and risk premium.

r=rRF+β×RPM

Here,

The cost of equity or required rate of return is “r”.

The risk-free rate is “rRF”.

The risk premium is “RPM” which is calculated as (rMrRF).

The market return is “rM”.

The beta coefficient is “β”.

The risk-free rate is 4%, market return is 12%, and beta coefficient is 2.5.

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