Question

If Starbucks has a CAPM beta of 1.3 and Caribou Coffee has a CAPM beta of 0.9, and the market average return is 7%, then the average rate of return of Starbcuks and Caribou Coffee should be (assume that the risk-free rate is zero)

3.1% and 6.30%, respectively

9.1% and 2.30%, respectively.

5.1% and 1.30%, respectively

Starbuck’s average return should be higher than Caribou Coffee’s because Starbucks has higher undiversifiable risk

Answer 1

Starbucks average return as per CAPM would be

Ke= Rf + Beta ( Rm- Rf)

= 0 + 1.3 (0.07 - 0)

= 1.3 (0.07)

=0.091 *100

=9.1%

Caribou coffee average return as per CAPM would be

Ke = Rf.+ Beta ( Rm- Rf)

= 0 + 0.9 (0.07 -0)

= 0.9 (0.07)

=0.063 *100

=6.3%

Since it is stated that Average return should be higher than caibou coffee's and since in the given options the 1st opt that is 3.1% and 6.30% is not possible and thus the above answer that is Average return of Starbucks would be 9.1% and Average return of Caribou coffee would be 6.3%.

Thus the Average rate of return of Starbucks is 9.1% which is considered to be higher than the Average rate of return of Caribou coffee which is only 6.3%.

Therefore answer would be 9.1% and 6.3% respectively.