The Abacus Computer Company has decided to use the Capital Asset Pricing Model t
ID: 2626287 • Letter: T
Question
The Abacus Computer Company has decided to use the Capital Asset Pricing Model to estimate its cost of equity. The firm's beta was estimated at 1.4. The S&P/TSX Composite-stock index has returned 12.5% to investors over a fairly long period of time, and Abacus has decided to use this value as the market return. Treasury bills are currently providing investors with a 6.5% yield.
A) Calculate Abacus's cost of equity using the CAPM.
B) If its beta was incorrectly estimated, and a new revised estimate of 1.8 was used in the calculations, what would its new estimate of the cost of equity be?
Show all the work.
Explanation / Answer
The CAPM formula is Kc = Rf + beta x ( Km - Rf )
where
Kc is the risk-adjusted discount rate (also known as the Cost of Equity);
Rf is the rate of a "risk-free" investment, i.e. cash;
Km is the return rate of a market benchmark, like the S&P 500.
A) Kc = 6.5% + 1.4
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