Question

Which one of the following is the most popular method for estimating the cost of equity?

• A. Capital asset pricing model
• B. Dividend yield method
• C. Gordon's dividend discount model
• D. Earnings yield method

Answer 1

Answer: (A)

Capital asset pricing model

Capital asset pricing model is the most celebrated model for estimating cost of equity.

It describes the relationship between risk and expected return. The general idea behind CAPM is that investors need two forms of compensation: time value of money and risk.

The risk-free rate in the formula represents the time value of money and compensates the investors for placing money in any investment over time.