Exercise 3 (40 points):

You need to estimate the equity cost of capital for XYZ Corp. You have the following data available regarding past returns:

year risk-free return market return XYZ return

2007 3% 6% 10%

2008 1% -37% -45%

e. Would you base your estimate of XYZs equity cost of capital on your answer in part (a) or in part (d)? How does your answer to part (c) affect your estimate? Explain.