Question

The market risk premium estimates vary quite a bit, depending on your source. What source would you use if you had to determine the cost of your equity-financed firm and were considering an investment of $500 million?

Answer 1

In order to calculate the market risk premium, we need the risk-free rate and the required rate from the market. The risk-free rate can be obtained from the long-term Treasury bond rate of the country in which we will set up our business and our stock will be listed. Similarly, the required rate of return from the market can be obtained by getting the CAGR (Compounded Annual Growth Rate) of market over the past 20-25 years. Hence, by subtracting the two, we will get the market risk premium.