7e7 Dreamliner

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Q1. I started with picking up a relevant risk-free rate (Rfr) for the CAPM to calculate the cost of equity; I learned that 10 years T-Bond rate was more appropriate rate to be utilized for the sake of Rfr; the reasons cited in the reading “Best Practices in Estimating the Cost of Capital: Survey and Synthesis” made sense that the long-term bond yields more diligently replicates the default free HPR available on long term investments and hence more closely reflects the different investing decisions made by the firms1. Therefore, I have selected Rfr of 4.05% on 10 years T-Bonds on January 1, 20032.
The real challenge for me was to pick a more appropriate equity risk premium (ERP), and I came across more than conflicting information on what number I should utilize for this purpose. As majority of the analysts, professors and textbooks have used MRP from a range of to 5% to 7.4%3. Moreover, most of the people said that they would utilize the “Arithmetic Historical Averages” for the ERP. Digging deep the issue of ERP, I came across few significant findings by Pablo Fernández and Aswath Damodaran. Fernández has conducted number of surveys and research on the appropriate ERP and comes up to a conclusion that there is no appropriate ERP for a market as whole and also that using the historical averages would not be suitable, since a lot has changed in the investment world and over the years the ERP has been seen to slide down from the historical averages4. Aswath Damodaran (2001), in his book “The Dark Side of Valuation” argues that the use of geometric average risk premiums (6.05%) for stocks over the T-Bonds the period of 1928-1999, poses serious questions and if someone uses them they are assuming that there have been no trends in the risk premiums and inherent risks of the market are the same as they were few decades ago. Aswath Damodaran in his research argues that although there is no right way to calculate the ERP, however using arithmetic averages will seriously

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