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You need to compute the cost of equity of Coca Cola Amatil (CCL). You are provided...

You need to compute the cost of equity of Coca Cola Amatil (CCL). You are provided with the arithmetic risk premium of 7.2%, the implied risk premium of 7.5%, the geometric risk premium of 6.0%, and the survey risk premium is 5.8%. If you decide to use a historical risk-free rate of 3.6% and believe that the market reverses to its historical means, which of the following risk premiums would you use in the CAPM to compute CCL's cost of equity?
Select one:
A. The implied risk premium of 7.5%
B. The survey risk premium of 5.8%
C. The arithmetic risk premium of 7.2%
D. The geometric risk premium of 6.0%

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Answer #1

We would be using the

Geometric risk premium of 6.0%

In CAPM model when we estimating one period rate then we should use the arithmetic risk premium (for example when we are using T bills as risk free rate), we should use the geometric risk premium when the historical (more than a period) risk free rate is being used. Implied risk premium is normally useful when the dividend discount model is being used. The survey risk premium should be used when there is no other reliable method.

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