¶ … equity at Facebook is to use the capital asset pricing model. The formula for CAPM is as follow:
Rj = RF + ?j [RM - RF]
The first step to determining the cost of equity is to gather the different variables go into CAPM. The risk free rate is the first such variable. The risk free rate reflects the rate of return that an investor can earn on an investment that has no risk The only investments that are deemed to have no risk are Treasury securities. This is because the U.S. Treasury prints money, so there is zero risk that these will not be repaid. There is risk that the payment will not have the same real value, but it will have the same nominal value as expected.
According to the U.S. Treasury webpage, a one-year Treasury bond carries with it a rate of 0.13%. This is the risk free rate to be used in the capital asset pricing model calculation.
The next step is to calculate the market risk premium. This is assumed to be 5%. This means that the component of CAPM that is [RM - RF] is 5%. The expression RM must be 6%, given this.
The remaining variable is the beta, which is the expression of the correlation between the performance of the company and performance of...
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