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Q: CAPM and Expected Return ( Answered ,   1 Comment )
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 Subject: CAPM and Expected Return Category: Business and Money > Accounting Asked by: buffcode-ga List Price: \$5.00 Posted: 03 Jun 2005 07:15 PDT Expires: 03 Jul 2005 07:15 PDT Question ID: 528909
 ```CAPM and Expected Return. The following table shows betas for several companies. Calculate each stock?s expected rate of return using the CAPM. Assume the risk-free rate of interest is 5 percent. Use a 9 percent risk premium for the market portfolio. Company Beta Cisco 2.03 CitiGroup 1.36 Merck .40 Walt Disney .84```
 ```Buffcode -- Louise Francis? article in Actuarial Review has a good discussion of cost of capital and beta that?s quite to the point: Actuarial Review ?The Risk Premium Project Releases Empirical Results,? (Francis, February 2004) http://www.casact.org/pubs/actrev/feb04/latest.htm So, the CAPM model says that the return to investors (and to the corporation, Rc) has to be equal to: ? the risk-free rate ? PLUS a premium for stocks as a whole that is higher than the risk-free rate. This market return premium is (rM ? rf) ? And the market return should be multiplied by the risk factor for the individual company, termed the ?beta of the corporation? (ßc) Expressed as a formula, it?s: Rc = rf + ßc(rM - rf) Where, Rc is the company's expected return on capital rf is the risk-free return rate, usually a long-term U.S. Treasury bill rate rM is the expected return on the entire market of all investments. Most measures use a common broad index, most often the S&P500 over the past 5 or 10 years ßc is the company's Beta, based on its covariance with the market. Rf = 5% rM = 9% Cisco = 5% + 2.03 (4%) = 13.12% Citigroup = 10.44% Merck = 6.6% Walt Disney = 8.36% Google search strategy: CAPM + beta + WACC ?Capital asset pricing model? + beta Best regards, Omnivorous-GA```
 ```The answer provided above is wrong I am an actuarial student from University of Waterloo, I have learned this in my Coporate Finance Class. According to CAPM Expected Return(R) = risk free rate of return(5% this case)+Beta(for each company) * Risk Premium Risk premium = market rate of return - risk free rate of return = Rm-Rf so the correct answers are Cisco = 5% + 2.03*(9%) = 23.27% Citigroup = 5%+1.36*(9%)= 17.24% Merck = 5%+0.40*(9%)= 8.6% Walt Disney = 5%+0.84*(9%)= 12.56% Thank you```