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Q: CAPM and Expected Return ( Answered 4 out of 5 stars,   1 Comment )
Question  
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
Answer  
Subject: Re: CAPM and Expected Return
Answered By: omnivorous-ga on 03 Jun 2005 07:36 PDT
Rated:4 out of 5 stars
 
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? (c)


Expressed as a formula, it?s:

Rc = rf + c(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
c 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
buffcode-ga rated this answer:4 out of 5 stars

Comments  
Subject: Re: CAPM and Expected Return
From: proanswer-ga on 30 Jan 2006 15:30 PST
 
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

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