Question

Here are data on two companies. The T-bill rate is 4.6% and the market risk premium is 8.9%.

Company $1 Discount Store Everything $5
Forecast return 15 % 14 %
Standard deviation of returns 22 % 24 %
Beta 1.4 1.0

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

Answer 1

Fair returns

$1 discount store = 17.06%

Everything $5 = 13.5%

Step-by-step explanation:

CAPM is used to calculate the expected return on an investment using risk free rate beta of asset and market risk premium. It is used to decide the addition of new investment in a well diversified portfolio.

Expected return = Risk free rate + Beta ( Risk premium)

Expected return of $1 discount store = 4.6% + 1.4 ( 8.9%) = 17.06%

Expected return of Everything $5 = 4.6% + 1.0 ( 8.9%) = 13.5%