Reference no: EM13297819
The cost of equity (discount rate) can also be determined by using the Capital Asset Pricing Model (CAPM). Calculating the cost of equity using the CAPM model is often more difficult than using the dividend discount model. The companies' financial statements do not show the cost of equity.
The following table shows necessary (hypothetical) information to calculate the cost of equity by using the CAPM model:
Company Listing RAF Rh, BI
Nike Inc. NYSE: NKE 0.40% 6.50% 0.90
Sony Corporation NYSE: SNE 0.40% 9.50% 1.60
McDonald's Corporation NYSE: MCD 0.40% 8.50% 0.40
E(19= RRF + Pj (RM - RRF)
E(ri) - The cost of equity RRF - Risk-free rate of return BI - Beta of the security
RM - Return on market portfolio Part II
Based on the above information, which company has higher cost of equity? Why? Briefly explain your reasoning.
The CAPM model shows that risk-free rate of return, return on market portfolio, and company beta determine the cost of equity.
What type of factors influence company beta? Briefly describe the factors that influence company beta. For example, higher financial leverage (total liabilities to total assets ratio) can lead to higher company beta.
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