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Question:

When using the CAPM to estimate the cost of common equity for a company in a developing country, an analyst should most appropriately:

A add a country risk premium to the market risk premium.
explanation

1212The appropriate method for estimating the cost of equity for a firm in a developing market is to add a country risk premium (CRP) to the market risk premium, so the revised CAPM equation becomes: The CRP is the sovereign yield spread (between yields on the country’s government bonds and a developed country’s government bonds) adjusted for the volatility of the developing country’s equity marker. An alternative approach is to add the CRP (not the sovereign yield spread) to the cost of equity as calculated from the CAPM.

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