Question

Problem #7 (5 Marks). At the beginning of 2014, Apple's beta was 1.4 and the risk-free rate was 4.5%. Apple's share price was $71.51. Apple's share price at the end of 2014 was $117.16. If you estimate the market risk premium to have been 6%, did Apple's managers exceed their investors' required return as given by CAPM? Show your work.

Answer 1

Solution:-

As per CAPM, the required return for a stock is calculated as follows:

Required rate of return = Risk-free rate + Beta*(Market risk premium)

At the beginning of 2014, Apple's required rate of return (Ke) is thus calculated as follows

Ke= 4.5% + 1.4*6% = 12.9%

Therefore, Apple's shareholders required a return of 12.9% in 2014. Let's calculate the return they got:

Apple's return in 2014= (year end price-year beginning price)/year beginning price = (117.16-71.51)/71.51 = 63.84%

Therefore, apple produced a return (63.8%) well over its required rate (12.9%). Hence, the managers exceeded their investor's expectations by a great margin.