Question

Here are data on two companies. The T-bill rate is 4% and the market risk premium is 6%.

Company $1 Discount Store Everything $5
Forecast return 12% 11%
Standard deviation of returns 8% 10%
Beta 1.5 1.0



What would be the fair return for each company, according to the capital asset pricing model (CAPM)?

Answer 1

14% and 11%

Step-by-step explanation:

In this question, we use the CAPM model formula which is shown below:

The expected return = Risk-Free Rate of Return + (Beta × Market Premium)

For Company, the expected return would be

= 5 + (1.5 × 6)

= 5 + 9

= 14%

For Discount store, the expected return would be

= 5 + (1 × 6)

= 5 + 6

= 11%

We ignored all other information which is given in the question