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Q: CAPM and Expected Return ( Answered 4 out of 5 stars,   1 Comment )
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
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)

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)


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,

buffcode-ga rated this answer:4 out of 5 stars

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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