a better estimate of expected returns.

13.You need to estimate the equity cost of capital for XYZ Corp. Unfortunately, you only have the following data available regarding past returns:

 

Year Risk-free Return Market Return XYZ Return
2007 4% 6% 8%
2008 1% -43% -50%

 

Would you base your estimate of XYZ’s equity cost of capital on historical return or expected return?

Expected return because the CAPM provides a better estimate of expected returns.

Historical return because the average past returns provides a better estimate of expected returns.