Question

a. (Required Rate of Return Using CAPM) Compute a fair rate of
return for Apple

common stock, which has a 1.5 beta. The risk-free rate is 8 percent
and the

market portfolio (New York Stock Exchange stocks) has an expected
return of

16 percent.

b. Why is the rate you computed a fair rate?

Answer #1

a)

According to CAPM, Required Rate of Return = Risk Free Return + Beta*(Market Return - Risk Free Return)

= 8 + 1.5*(16 - 8)

= 20%

Fair Rate of Return = 20%

b) It is fair rate because the general idea behind CAPM is that investors need to be compensated in two ways: time value of money and risk.

Risk free rate represents the time value of money and compensate the investors for investing money in any investment over a period of time. It considers premium on market. Hence it is called fair rate.

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