Which of the following statements about costofequity estimat

Which of the following statements about cost-of-equity estimation is most correct?

Solution

There are usually three methods to determine cost of equity, CAPM model, Debt yield plus risk premium, and dividend discount model.

Capital Asset pricing model is one of the best way to determine the cost of capital (Equity capital). the variable use in determining the cost of capital using CAPM model is, Risk free rate of return, market return and beta.

Risk free rate of return is minimum return that investor wants when level of risk is zero. according the risk and return relationship when risk will increase the required rate of return will also increase. Market return is the overall return in market. the difference between market return and risk free rate is called risk premium.

Beta is a measure of level of risk in investment. when beta of the company is changed that is level of risk change then the cost of capital of company is also change.

Capital assets pricing model formula for calculation of cost of equity is mention below:

Cost of equity = Risk free rate + (Market Return - Risk free rate) × Beta

Option (A) is correct answer.