Corporate Finance

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Corporate Finance

The CAPM parameters can be estimated individually, as demonstrated in the preceding sections, and then
plugged into CAPM to arrive at the cost of equity.

Exhibit 4.5 Risk premia for select Asian countries

MRP Rf Historical Measurement
Country Index (percent) (percent) premium (percent) period

Singapore STI 6 4 8 1987–95
Taiwan TWSE 6.5 7 10 1986–96
Korea KOSPI 6.5 10 6 1985–96
Malaysia KLSE 8 7 8.5 1985–96
Hong Kong HIS 7.5 8 8.8 1969–96
Thailand SET 9 13.5 14 1986–96
India BSE 100 8 13 10.5 1991–96

Source: C S First Boston.

Exhibit 4.6 Equity premia (in percent)—US data, 1802–1998

Equity premium Equity premium
with bonds with bills
Period Arithmetic Geometric Arithmetic Geometric

1802–1998 3.5 4.7 5.1 5.5
1802–70 2.2 3.2 1.9 2.9
1871–1925 2.9 4.0 3.4 4.6
1926–98 5.2 6.7 6.7 8.6
1946–98 6.5 7.3 7.2 8.6

Source: Siegel (2001).

An Illustration

The cost of equity for Reliance is estimated below:

Rf= 12.15 percent

Market premium, Rm – Rf= 10 percent

β= 1.54

Cost of equity = 12.15 + 1.54(10)

= 27.55 percent

If we were to use the short term T-bill rate,

Cost of equity = 8 percent + 1.54(10)

= 23.4 percent

The difference is of about 4 percent. There is no total consensus on how the CAPM parameters are to be
estimated.