CFA CFA Level 1 Cost of Capital

# Cost of Capital

• Author
Posts
• fmccray
Participant
• CFA Level 1
6

This question is asking for Cost of equity.

Project Beta 1.5

Risk free rate 3%

Country risk premium for China 2.6%

a – 18.9%

b- 14.40%

c- 10.40%

the answer key has 18.9% is correct.

but, what i calculated following the formula is 14.40%.

Ke = frf+B((Risk premium) – frf + CRP)

Ke= 0.03+1.5(0.08-0.03+0.026)

Ke= .1440

to get 18.9% i have to exclude 0.03 from risk premium. but if i do it according to formula is .1440.

• 5

Hi @fmccray , of course you can ask questions, that’s what this community is for ðŸ™‚

Your formula is correct: Ke = risk-free rate (rfr) + B [ E(Rm) – rfr + CRP ]

However, the question had a little “trick” here, where they provided the info Market Risk Premium = E(Rm) – rfr = 8%, which already takes into account the risk free rate, hence a ‘premium’ over the rfr.

So your Cost of Equity, Ke = rfr + B*[8% + CRP] = 3% + 1.5*(8% + 2.6%) = 18.9%

• fmccray
Participant
• CFA Level 1
1

Thank you Sophie.