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COST OF CAPITAL
Ordinary equity (ke)
Capital Asset Pricing Model (CAPM):
Ke = Rf + B (Rm – Rf) Rf = risk free rate (returns/outcome is known
with certainty, therefore if no uncertainty then
no risk). Examples: government bond/ gilt rate.
B = Beta (systematic / market risk). Beta shows
the risk of the company relative to the market.
Example: Rm= market rate of return.
Rm – Rf = market risk premium.
The risk free rate is 6%
Beta is 1.4
The market risk premium is 5% (therefore the market rate = 11%)
Calculate the cost of equity.
Ke = Rf + B (Rm – Rf)
= 6 + 1.4 (5)
= 13%
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