CFA CFA Level 1 Cost of Capital

Cost of Capital

  • This topic has 2 replies, 2 voices, and was last updated Jan-21 by fmccray.
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    • fmccray
      Participant
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      May i ask for help on this? Thank you in advance.

      This question is asking for Cost of equity.

      Project Beta 1.5

      Risk free rate 3%

      Market risk premium 8%

      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.

    • Sophie Macon
      Keymaster
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      Hi @fmccray , of course you can ask questions, that’s what this community is for 🙂

      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
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      Thank you Sophie.

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