What is the expected return on common equity according to the model?

The expected return on common equity is calculated using the Capital Asset Pricing Model (CAPM), which is fundamentally represented as the risk-free rate plus the product of the equity's beta and the market risk premium. The model states that the expected return on an asset increases with higher risk as measured by beta.

In this context, the expected return on common equity can be succinctly described by the formula: Rf + Bce * (Rm - Rf). Here, Rf represents the risk-free rate, Bce denotes the beta of the common equity, and (Rm - Rf) is the market risk premium, which reflects the additional return expected from investing in the market over the risk-free rate. This relationship captures the idea that investors need to be compensated for taking on additional risk.

The first part of the formula (Rf) captures the time value of money—the return that investors can earn without taking any risk. The second part, Bce * (Rm - Rf), introduces the risk component, which is crucial for equity investments, encapsulating how much extra return (or premium) investors can expect based on the specific risk profile of the equity.

This method is widely used in finance to estimate the expected return on equity investments, making the