Question

Compute Metcash (MTS) cost of equity using CAPM. Show the complete calculation process and how you...

Compute Metcash (MTS) cost of equity using CAPM.

Show the complete calculation process and how you acquire the values to be used in the model.

Justify your choice of the risk-free rate, market risk premium and the company beta value. State the cost of equity and comment on the limitation of using that value directly, in relation to the imperfections of the CAPM.

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Answer #1

COE using CAPM Model = risk free rate+(beta*Market Risk Premium)

COE should be more than the risk free rate beacuse the risk taken is higher in the equity, but how much more it should be is calculated using beta and market risk premium.market risk premium is nothing but the difference between expected returns and the risk free rate. beta measures the sensitivity of the security towards the market.so, beta should be multiplied with market risk premium so as to reach the extra cost other than the risk free rate.

some of the limitations of CAPM are:it is difficult to arrive at risk free rate as the value changes daily.calculating of beta using the market data may not be realistic which deviates from the fair value

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