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Example of Capital Asset Pricing Model
KK Ltd is an all equity firm whose Beta factor is 1.2, the interest rate on T. bills is currently at 8.5% and the market rate of return is 14.5%. Conclude the cost of equity Ke, for the company.
Solution
Rf = 8.5% , Rm = 14.5% and Beta of equity = 1.2
Ke = Rf + (Rm - Rf)BE
= 8.5% + (14.5% - 8.5%) 1.2
= 8.5% + (6%)1.2
= 15.7%
risk structure of interest rates 1. Default risk 2. Liquidity 3. Income tax consideration 4. Expectations theory
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