According to the CAPM, the cost of equity is the sum of the risk-free rate and a risk premium which depends on the riskiness of the firm relative to the riskiness of the stock market as a whole. The underlying idea is that investors can diversify risks which are not correlated with the stock market as a whole by buying shares in a large number of companies. Risks which are correlated with the market cannot be diversified away and so form a component of the cost of equity. A.5 All the parameters of the CAPM may be estimated empirically, although there is no universal agreement on the appropriate methodology. The most difficult parameter to estimate accurately in the present case is beta.
Estimation relies on share price data.
However, many service providers are not quoted companies or are part of larger groups whose share prices reflect the performance of a number of diverse activities. One possibility in these circumstances would be to use a sector or company average beta. Beta for the telecommunications sector as a whole has been estimated at 1.08, although this must have been heavily influenced by BT's beta which is substantially lower. There may therefore be grounds for thinking that an appropriate beta for service providers would be somewhat greater than 1.08. Service provision is a competitive activity and this is likely to increase volatility and hence beta.