Question

Here are data on two companies. The T-bill rate is 4.6% and the market risk premium is 8.9%. Company $1 Discount Store Everything $5 Forecast return 15% 14% Standard deviation of returns 22% 24% Beta 1.4 1 What would be the fair return for each company, according to the capital asset pricing model (CAPM)? (Round your answers to 2 decimal places.) Company Expected Return $1 Discount Store % Everything $5 %

Answer 1

As per Capital Asset Pricing Model [CAPM], The Expected Return is calculated by using the following equation

Expected Rate of Return = Risk-free Rate + (Beta x market Risk Premium]

Here, we’ve Risk-free Rate (Rf) = 4.60%

Market Risk Premium (Rm – Rf) = 8.90%

Expected Return - $1 Discount Store

Expected Rate of Return = Risk-free Rate + (Beta x market Risk Premium]

= 4.60% + (1.4 x 8.90%)

= 4.60% + 12.46%

= 17.06%

Expected Return - Everything $5

Expected Rate of Return = Risk-free Rate + (Beta x market Risk Premium]

= 4.60% + (1 x 8.90%)

= 4.60% + 8.90%

= 13.50%

Therefore, the Expected Return - $1 Discount Store = 17.06%

Expected Return - Everything $5 = 13.50%