Suppose the compensation for risk is based on the market risk and that market risk is estimated as the product of the asset’s beta and the market risk premium for the market as a whole (that is,

− rf). Calculate the cost of capital for each of the possible comrm binations of compensation for the time value of money and compensation for risk:LO3

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Risk-free rate of interest Asset beta Market risk premium (a) 3% 1.00 4% (b) 4% 0.50 5% 5% 1.50 6% (d) 4% 1.00 4% 5% 1.25 4%