

Subject:
CAPM and Expected Return
Category: Business and Money > Accounting Asked by: buffcodega 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 riskfree 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: omnivorousga on 03 Jun 2005 07:36 PDT Rated: 
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 riskfree rate ? PLUS a premium for stocks as a whole that is higher than the riskfree 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 riskfree return rate, usually a longterm 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, OmnivorousGA 
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Subject:
Re: CAPM and Expected Return
From: proanswerga 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 = RmRf 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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