Cost of Common Equity: Capital Asset Pricing Model Approach

Using the capital asset pricing model (CAPM) approach to a cost of common equity estimation, a beta of 0.8 for a firm suggests that its cost of equity is _most accurately_ stated as:

Incorrect. The beta is not directly transferable to a cost of common equity estimate without additional information.

Incorrect. Recall that the market portfolio has a beta of 1 by definition. A stock with a beta of 0.8 would have less market risk than that of the market portfolio.

Correct! The beta of 0.8 tells you that the firm has less market risk than that of the market portfolio but does have some positive level of market risk. The CAPM-estimated cost of common equity would therefore lie between the return of the risk-free rate and the estimated return of the market portfolio.

greater than the estimated market portfolio return.

approximately 80% of the expected market portfolio return.

somewhere between the risk-free rate and the estimated return of the market portfolio.