Forums › ACCA Forums › ACCA FA Financial Accounting Forums › How to deal with CAPM in WCCA
- This topic has 1 reply, 2 voices, and was last updated 9 years ago by John Moffat.
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- November 28, 2015 at 12:01 am #285824
So I faced the following problem which I will try to explain with 2 examples:
The CAPM formula is: Ke = Rf + ? (Rm – Rf)
where:Ke = cost of equity
Rm = return of the market
Rf = risk-free rate of return
(Rm – Rf) = equity risk premium
? = beta value of ordinary shareIn the firts example, presented in presentation by teacher he solve it like this
Establish beta value e.g. 1.2
Obtain risk premium data for the company and industry sector e.g. 8%
Ascertain risk free cost of capital e.g. 3%
Ke = 3% + 1.2( 8%) = 9.9%My question here is why he igrnored the (Rm – Rf) and multiplied beta by 8% and not by 5% ?
I also found similar example in google:
If the risk-free rate is 3%, the expected market risk premium is 5%, and the company’s stock beta is 1.2, what is the company’s cost of equity?
Solution:
Cost of equity = 0.03 + (1.2 × 0.05) = 0.03 + 0.06 = 0.09, or 9%Again, ignore of (Rm-Rf) – why?
While the 3rd example shows the things as I believe that have to be:
Getting beta from equivalent stand-alone traded firms: e.g., ? =1.4
Calculating expected rate of return (the “hurdle rate”):
e.g., rf = 5%, E(rM)=13%
So: E(rproject) = 0.05 + 1.4 (0.13-0.05) = 16.2%I will be very greatefull if somebody is able to explain me that differennce and what caused it?
Thank you in advance.November 28, 2015 at 8:29 am #285853If you want me to answer then you must ask in the Ask the Tutor Forum – this forum is for students to help each other.
Also, you have posted this in the F3 Forum.
CAPM is not examinable in Paper F3 – you should post in the F9 forum.If the question gives you the risk premium, then this is already Rm – Rf !
If the question gives you the market return, then this is Rm and you then need to subtract Rf to get the risk premium.I do suggest that you watch our free F9 lectures on CAPM. Our lectures are a complete course covering everything you need to pass the exam well.
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