Question

Hello, the stock I was assigned is NRG. I need to answer the following question:

Estimate discount rate using CAPM (Please provide details on your estimation. You need to estimate risk free rate and market risk premium. A reasonable risk free rate should be between 2%-3% and reasonable risk premium should be between 5%-9%).

Can you help me out?

BETA VALUE 1.03

Answer 1

Solution :

The CAPM formula is used to find the cost of equity ( Discount rate) and the formula is

Cost of equity = Risk-free rate + Beta * Market risk premium

Risk-free rate = 3.0334 %, We can 10 years US T-bond as risk-free rate because govt bonds are generally considered as risk free

Market risk premium : For market risk premium we can analyze the past years' return as compared to the risk-free rate.

We can get this data from various sites

Damodaran does the calculation for this and the value is 5.08%

Cost of equity =  3.0334 % + 1.03 * 5.08% = 8.27%