Question

# The CAPM states that the required rate of return on common equity is primarily a function...

The CAPM states that the required rate of return on common equity is primarily a function of a single variable. Agree or disagree, and why.

If a firm had earnings per share in 2010 of \$2, and 2015 EPS of \$2.80, the firm’s earnings growth rate (g) exceeded 5% per year. Agree or disagree, and why.

1)

Disagree

Single variable function is when a function has a single input value and produces a single output.

So the output is dependent on one variable.

Let us look at the CAPM model

Re = Rf + beta * (Rm - Rf)

Re = return on equity

Rf = risk free rate

Hence we can see that the CAPM model in order to calculate the return on equity depends on multiple variables.

Hence it is a multivariate function

ariable.

Lets look at the CAPM model

Re = Rf + beta * (Rm - Rf)

Re = return on equity

Rf = risk free rate

Hence we can see that the CAPM model inorder to calculate the return on equity depends on multiple variables.

Hence it is a multivariate function.

2)

Agree

2010 = \$ 2

2015 = \$ 2.8

overall earnings growth rate = ( 2.8 - 2 )/2 = 0.4 = 40%

earnings growth rate per year = 40/5 = 8%