Question

Answer the following CAPM questions in Excel. Show your work

Assume that Blast Company has a Beta of 0.85, the Risk Free Rate is 2.0% and the Expected Market Return is 6.75%.

i. What is the Required Rate of Return for Blast Company?

ii. Now assume that the Risk Free Rate is the same, but the Market Return is 7.5%. What is the Required Rate of Return for Blast Company now?

Answer 1

As per Capital Asset Pricing Model (CAPM)

Re = Rf + (Rm-Rf) β

Where Re = Required rate of return

Rf = Risk free rate of return

Rm – Market Return or Expected Market Return

β – Beta

i. Calculation of Required rate of return

Rm = 6.75 %

Rf = 2 %

β = 0.85

Using the formula Re = Rf + (Rm-Rf) β

= 2 + (6.75 - 2) 0.85

= 2 + 4.75 * 0.85

= 2 + 4.0375

= 6.0375 %

The Required rate of return is 6.0375 %

ii. Risk free rate same but market return is now 7.5%

Rm = 7.5 %

Rf = 2 %

β = 0.85

Using the formula Re = Rf + (Rm-Rf) β

= 2 + (7.5 - 2) 0.85

= 2 + 5.5 * 0.85

= 2 + 4.675

= 6.675 %

The Required rate of return is 6.675 %