Describe the rationale of the CAPM approach. What are the pros and cons of using the CAPM for cost of capital purposes? Based on the Table 1 data, what is a reasonable range for the CAPM estimate? What are the major sources that one can go to for estimates of the parameters used in the CAPM equation, and what are the potential errors in those parame- ters?

Table 1. Data Used in the Analysis a. Bond Data. Two dollar-denominated bonds are currently outstanding. Bond A has a 6.75 percent semiannual coupon, Selis for 88.75 percent of par, matures on July 1, 2029, and can be called at a price of 1 on July 1, 2009. Bond B has a 9.0 percent semiannual coupon sells for 112.25 percent of par, also matures on July 1, 2029, and can be called at a price of 107.50 on July 1, 2009. PNC's federal-plus-state tax rate is 40 percent. Assume that the analysis is eonducte on September 15, 2004, and use this as the settlement date, i.e., the day the bond will be purchased. New bonds carrying the prevailing rate could be sold to insricutional investors, and no bond flotation cost would be involved Preter d Stock Data, PNC has one issue of preferred stock outstanding, a perpetual and non callable preferred that pays a $6.25 annual dividend, has a $100 par value, and currently is for $104 per share. Investment bankers have indicated that PNC could sell additional shares with a dividend rate that would provide the same market yield, but would incur a flotation cost of 2%. Also, it could sell at par an issue of sinking fund preferred with an annual coupon of 5.25%. The sinking fund would require the company to retire 10% of the original shares each year after issuance, and it too would have a 2 percent flotation cost