Cost of Equity Calculation: Bond-Yield-plus-Risk-Premium Approach

Bond-Yield-plus-Risk-Premium Approach

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Question

Which of the following equations correctly illustrates the calculation of the cost of equity using the Bond-Yield-plus-Risk-Premium approach?

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Explanations

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A. B. C. D. E. F.

F

The Bond-Yield-plus-Risk-Premium approach is a rather ad hoc method used by financial managers to determine the cost of common equity. Under this approach, a subjective risk premium is added to the yield to maturity of the firm's outstanding long-term debt. Typically, senior debt is used when possible, however, due to the ad hoc nature of this approach, there is abounding room for flexibility. This large degree of flexibility both adds to and detracts from the attractiveness of Bond-

Yield-plus-Risk-Premium approach.

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