When to use treasury bond rate and treasury bill rate as risk free rate!!!

CFA Level I
#1

A company wants to determine the cost of equity to use in calculating WACC.

rate of return on 3month treasury bill = 3.0%

rate of return on 10yr treasury bond = 3.5%

market equity risk premium = 6.0%

company’s estimated beta = 1.6

company’s after-tax cost of debt = 8.0%

risk premium of equity over debt = 4.0%

corporate tax = 3.5%

using CAPM approach, the cost of equity is closest to?

a. 7.5. B. 12.6. C. 13.1

SOLUTION:

3.5 + 1.6x (6) = 13.1%

source: 2010 cfa mock

WHY DIDNT THEY USE 3% AS THE RISK FREE RATE???

#2

Because it is better to use return on 10yr treasury bond as the risk free rate

#3

Solution should be 3.5 + 1.6 * 6 = 13.1

#4

Yh my bad. Typo

#5

Why? That’s what I want to know

#6

Probably because an equity investment is (generally) considered a long-term investment, so a long-term risk-free rate is more appropriate (more in line with the investment objectives) than a short-term rate.

That’s the reasoning I’d use. I don’t know if that’s what CFA Institute thinks.

#7

Thanks. Makes sense.