Confusion with CAPM/ Cost of Equity

CFA Level I Equities
#1

Hey, I am a bit confused regarding how to calculate k, when provided a company’s beta, the risk-free rate, and market premium. Here is an example question:

'Pam Robers, CFA, is performing a valuation analysis on the common stock of Allstare Inc. The stock’s beta is 1.1, the risk-free rate is 5%, and the market risk premium is expected to be 8%. Allstare’s ROE is expected to be constant at 18%, and its dividend payout ratio has been fairly constant over time at 40%. The forward-earnings multiplier that Robers should use to estimate the current value of the shares is closest to:;

A) 13
B)20
C)7

I was under the impression that in order to calculate k, you have to do Rf + B(Rm-Rf) however I have seen in many circumstances, as well as in this answer that they only do Rf+B(Rm). Is someone able to clarify why this is the case?
Thank you!

#2

When the question says “market risk premium” that means the number given to you already has the risk free rate subtracted. In other words:
Market risk premium = Rm-Rf

So when you have the market risk premium, you calculate k as k = rf + Beta(market risk premium)

If you are just given the return of the market, then your method of calculation is correct.

1 Like
#3

Ahh, of course - a silly mistake to be making. Thank you!