According to the capital asset pricing model the expected return on a security is equal to the return on a risk-free investment plus an equity market risk premium. In recent years, there has been considerable debate about the size of the equity market risk premium [E(rM) - rF]. Most textbooks give a range between 4% to more than 6%. However some of the major investments banks use an equity market risk premium as low as 3% when they compute the cost of capital for valuing a company in merger or other transactions. How could rates as low as 3% be justified when E(rM) is in the range of 9% to 11% and rF (long term government bonds) is in the range of 3% to 5%? What are the possible arguments used by the banks? If you were buying another company, would you agree to such a low rate? What if you were the selling firm