scr879

yeah, this one is tricky one...

I'm going to add to Anna237's response... "equity risk premium is the difference between the return on equity and the return on bonds in this case". So Ke being the Cost of Equity is not the same as Equity Premium being -- [Ke-Kd=Equity premium]

Look at it this way...at one point in time, weigh the cost of capital... typically is as follow:
EQUITYarithmetic > EQUITYgeometric > longterm bongs > short term bonds

And so... [EQUITYarithmetic-short term bonds] > [EQUITYgeometric-longterm bonds]
or... EQUITY RISK PREMIUM ar-stb > EQUITY RISK PREMIUM gm - ltb

ar- arithmetic mean
stb-short term bonds
gm-geometric mean
ltb-long term bonds

I don't think Kd is synonymous with Rf. The problem does not specify the type of bonds the calculation is using. As you know, Kd for a corporation includes default risk while Kd for the government is calculated default-risk free...



Edited 1 time(s). Last edit at Wednesday, April 7, 2010 at 10:42AM by bizzies4bankers.