Question 1

Section B - Case 2: NeuroLink Prosthetics

Scenario: NeuroLink Prosthetics is a MedTech firm. It has 10 million ordinary shares in issue, currently trading at $4.50 per share. The company's equity beta is 1.2. The risk-free rate of return is 4% and the expected return on the market portfolio is 10%. NeuroLink also has $15 million (nominal value) of 6% redeemable bonds, currently trading at $95 per $100 nominal, redeemable at par in 5 years. The corporate tax rate is 25%.

Question: Using the Capital Asset Pricing Model (CAPM), what is NeuroLink's cost of equity?

Accepted Answer

Apply the CAPM formula: Ke = Risk-free rate + Beta * (Market Return - Risk-free rate). Note that the 'expected return on the market' is Rm, not the market risk premium.

Question 2

What mistakes do candidates make on this ACCA question?

Accepted Answer

Treating the 10% market return as the market risk premium (Rm - Rf). If the question says 'market risk premium is 10%', you don't subtract the risk-free rate. Here it says 'expected return on the market', so you must subtract it.

How to approach this question

Full Answer

Common mistakes

Practice the full ACCA FM — Financial Management Practice Exam 6

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