Question

0.33

0.52

0.72

Using the average of the betas and making appropriate assumptions for other inputs, estimate an expected return for your firm. Justify your assumptions. Interpret the expected return.

Answer 1

Average of the betas = (0.33 + 0.52 + 0.72) / 3= 0.5233

Using CAPM to find the expected return:

Expected return = Risk free rate + Beta * (Market return - risk free return)

Assuming that the market is bearish , then the expected market return is high and the risk free rate of return is usually lesser. Also here the beta is less than 1, which means the stocks are volatile but less than the market. in this case the stock is 47.67% (1 -0.5233) less risky than the market index.

Inputs:

Risk free rate = 4% [ can be derived through T-Bills rate]

Expected market return = 12%

Average beta = 0.5233

expected return = 4% + 0.5233 ( 12% -4%)

= 8.18%

The expected return is lesser than the market return which means that the stock may not yield as per the market return. Higher the beta higher the expected returns.