Under CAPM, we take the after-tax cost of debt. For risk free rate, we use 10yr gov bonds as a proxy and if the bonds make coupon payment, do we take after tax cost of risk free to recognise tax rate on government bond?

Question

anonymous · Answer

CAPM does not account for the cost of debt. The WACC however does account for after tax cost of debt. The risk free rate must coincide with the duration of beta. There is no set in stone measure that says you must take the 10 year bond.

anonymous · Answer

I believe you probably have to use a maturity that coincides with your investment horizon. If this is equity, and intend to value the equity, then the longest term possible would give the best proxy for risk-free rate. This will reduce reinvestment rate (fluctuation in interest rate).

Since CAPM is used to calculate the required return of the equity investment, and you're probably interested in finding a proxy for the risk-free return, an after-tax return from government bond with maturity matching investment horizon should be used.