

Subject:
Finance
Category: Business and Money > Finance Asked by: baseball2ga List Price: $5.00 
Posted:
24 Jul 2005 18:55 PDT
Expires: 23 Aug 2005 18:55 PDT Question ID: 547402 
Am I figuring CAPM correct for the following scenerio: Company B has a beta of 2.03 . The risk free rate of interest is 5 persence. I am using a 9 percent risk premium for the market partolio. .05 + 2.03 * (0.09 0.05) = 13% Is this correct? Thanks 

Subject:
Re: Finance
Answered By: websearcherga on 24 Jul 2005 19:34 PDT Rated: 
Hello baseball2: No, you're not quite calculating CAPM correctly. The formula you should be using for CAPM for this question is: E(R) = r + ERP * beta E(R) = expected return r = riskfree interest rate ERP = equity risk premium So, for your figures, the formula is: E(R) = r + beta * ERP = 5% + 9% * 2.03 = 23.27% The mistake you were making was confusing the risk premium with the expected return. The more expanded version of the CAPM formula is: E(R) = r + beta * (E(Rm)  r) where E(Rm) is the expected return of the market and (E(Rm)  r) is used to calculate the risk premium. So, basically, if you're given the ERP value, you do not need to subtract the riskfree value from it  it's already been subtracted. Sources: Capital asset pricing model URL: http://en.wikipedia.org/wiki/Capital_Asset_Pricing_Model Free Money and the Capital Asset Pricing Model URL: http://www.sherlockinvesting.com/articles/capm.htm Capital Asset Pricing Model URL: http://210.210.18.114/EnlightenmentorAreas/finance/CFA/capm.htm Search Strategy (on Google): * CAPM beta "risk free" interest "risk premium" I hope this helps. websearcher 
baseball2ga
rated this answer:
Thank you very much! Very helpful. 

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