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If the firm's bonds earn a return of 8%, then what would be your estimate of rs using the...

Question:

If the firm's bonds earn a return of 8%, then what would be your estimate of rs using the own-bond-yield-plus-judgmental-risk-premium approach?

Required Return On Equity:

The required rate of return on equity is the opportunity cost, from the investor's perspective, that investor will give up other available investment to elect equity investment. This rate of return is expected to be greater than other investment returns.

Answer and Explanation:

Own-Bond-Yield-Plus-Judgmental-risk-premium approach

{eq}r_s = r_d + Equity\:risk\:premium {/eq}

{eq}Equity\:risk\:premium = Historical\:equity\:return - Risk-free\:rate {/eq}

Usually, the equity risk premium will be in the range, 5% - 7%.

Assume that the equity risk premium is 6%.

{eq}r_s = 8\% +6\% = 14\% {/eq}


Learn more about this topic:

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Required Rate of Return (RRR): Formula & Calculation

from Financial Accounting: Help and Review

Chapter 1 / Lesson 29
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