The appropriate risk-free rate to use when calculating the cost of equity for a firm is
A) a long-term Treasury rate.
B) a short-term Treasury rate.
C) an equal mix of short-term and long-term Treasury rates.
D) None of the above

Question

Quizplus · Accepted Answer

The appropriate risk-free rate to use when calculating the cost of equity for a firm is a long-term Treasury rate because the cost of equity reflects the expected return that investors demand for investing in the firm's equity. The long-term Treasury rate is the most appropriate measure of the risk-free rate because it represents the return on a risk-free investment that has a maturity similar to the life of the firm's operations. Short-term Treasury rates are too volatile and do not reflect the long-term nature of the cost of equity, and an equal mix of short-term and long-term rates would not be appropriate because long-term rates are more relevant for the cost of equity calculation.

The Appropriate Risk-Free Rate to Use When Calculating the Cost