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If an investor moves money from the risk-free asset into the stock market, they should expect to earn a return in excess of the risk-free rate, what is called an equityrisk premium. What Impacts the Capital Asset Pricing Model? Investments are exposed to two types of risk: systematic and unsystematic.
Different types of discount rates such as risk-free rate, cost of equity, or cost of debt, are used contextually in financial analysis. In DCF analysis, the WeightedAverageCost of Capital (WACC), representing the average return required by all stakeholders, is commonly used as the discount rate.
Cost of Equity and Capital: The Terminal Growth Rate is used to calculate the cost of equity in the Dividend Discount Model (DDM) and the cost of capital in the WeightedAverageCost of Capital (WACC) formula.
Weightaveragecost of capital (WACC) is a calculation of a firm’s cost of capital which includes all sources of capital such as common stocks, preferred stocks, and bonds. A firm uses a mix of equity and debt to minimize the cost of capital.
d is the discount rate (which is usually the weightedaveragecost of capital (WACC), r in our previous example). Ce = Cost of Equity. Rf = Risk-free Rate. Rm – Rf) = EquityMarketRisk Premium. Cp = Cost of Equity Premium. Ce = Cost of Equity.
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