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Hello, this might be a simple question but I really don’t understand it, will really appreciate it to get some help on it. Thank you.
—Coeden Co—
1.
The answers calculated the cost of equity by using:4% + (1.1*6%) = 10.6%
Why is it that we times the equity beta with the market risk premium to get the cost of equity. I don’t understand what is the relationship between equity/asset beta with market risk premium, and how does that allow us to get cost of equity?
2.
I get very confused when I have to ungear and regear the betas. I failed the last AFM attempt because partly because I got confused of it during exam. How can I break it down into smaller pieces and digest so I don’t get confused during exam?Many thanks!
The market risk premium is the excess of the average return of the market as a whole over the risk free rate. Individual shares are more or less risky that the market as a whole (and this is measured by the equity beta) and so the premium over risk free for each individual share is beta times the market premium.
I do suggest that you watch my free lectures on all of this because I so explain it all (and the situation regarding gearing and ungearing betas) in detail, with examples.
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