What is the formula for calculating the cost of equity using the SML (Capital Asset Pricing Model) approach?

The correct formula for calculating the cost of equity using the Security Market Line (SML) approach, which is derived from the Capital Asset Pricing Model (CAPM), is articulated in the first option. The formula is represented as RE = Rf + Be[E(RM) - RF].

In this formula, RE stands for the cost of equity, Rf represents the risk-free rate, Be is the beta of the equity, E(RM) is the expected return of the market, and RF is also the risk-free rate. The beta measures the sensitivity of the stock's returns to the returns of the market, while E(RM) - Rf is known as the market risk premium, which reflects the additional return expected from investing in the market over a risk-free investment.

The SML provides a graphical representation of the expected return of a security as a function of its systematic risk (beta). By using this formula, investors can determine the appropriate return for taking on additional risk associated with equity investments compared to risk-free options. It essentially connects the level of risk (beta) with the expected returns, allowing for informed investment decisions.

On the contrary, the other options provided do not correctly reflect the CAPM methodology or misinterpret its components