Question

Paul Sharp is CFO of Fast Rocket Inc. He tries to determine the cost of equity financing for his company. The stock has a beta of 2.10. Paul estimated that the market return is 8.04%. The current rate for 10-year Treasury Bonds is 4.21%. Calculate cost of common equity financing using CAPM – SML formula.

Round the answers to two decimal places in percentage form. (Write the percentage sign in the "units" box)

Answer 1

SML Ret or CAPM Ret = Rf + Beta ( Rm - Rf )

Rf = Risk free ret
Rm = Market ret
Rm - Rf = Risk Premium
Beta = Systematic Risk

Particulars	Amount
Risk Free Rate	4.210%
Market Return	8.040%
Beta	2.1000
Risk Premium ( Rm - Rf)	3.83%

Beta Specifies Systematic Risk
Systematic risk specifies the How many times security return will deviate to market changes.
SML return considers the risk premium for Systematic risk alone.Where as CML return considers risk premium for Total risk.
Beta of market is "1".

SML Return = Rf + Beta ( Rm - Rf )
= 4.21 % + 2.1 ( 3.83 % )
= 4.21 % + ( 8.04 % )
= 12.25 %

Rf = Risk Free Rate