The SML Approach Use the following information to compute our cost of equity 0 Risk-free rate,Rf 0 Market risk premium,E(RM)-R Systematic risk of asset,B R=R+B:(E(Ry)-R) 10
10 The SML Approach n Use the following information to compute our cost of equity q Risk-free rate, Rf q Market risk premium, E(RM) – Rf q Systematic risk of asset, ( ( ) ) RE Rf E E RM Rf
Example:SML Suppose your company has an equity beta of .58 and the current risk-free rate is 6.1%. If the expected market risk premium is 8.6%,what is your cost of equity capital? ▣RE=6.1+.58(8.6)=11.1% ■ Since we came up with similar numbers using both the dividend growth model and the SML approach,we should feel pretty good about our estimates 11
11 Example: SML n Suppose your company has an equity beta of .58 and the current risk-free rate is 6.1%. If the expected market risk premium is 8.6%, what is your cost of equity capital? q RE = 6.1 + .58(8.6) = 11.1% n Since we came up with similar numbers using both the dividend growth model and the SML approach, we should feel pretty good about our estimates