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The following table shows betas for several companies. Calculate each stock’s expected rate of return using...

The following table shows betas for several companies. Calculate each stock’s expected rate of return using the CAPM. Assume the risk-free rate of interest is 6%. Use a 8% risk premium for the market portfolio. (Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places.)

Company Beta Cost of Capital
Caterpillar 1.81 %
Apple 1.45 %
Johnson & Johnson 0.64 %
Consolidated Edison 0.36 %
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Answer #1

Risk-free rate = RF = 6%

Market risk premium = (RM - RF) = 8%

CAPM Equation

Expected return on an investemnt i is given by:

E[Ri] = RF + βi*(RM - RF)

where, RF = Risk-free rate, βi = beta of the investment i, (RM - RF) = market-risk premium

Caterpillar

Beta of caterpillar = βC = 1.81

Expected return on Caterpillar = E[RC] = RF + βA*(RM - RF) = 6% + 1.81*8% = 20.48%

Apple

Beta of Apple = βA = 1.45

Expected return on Apple = E[RA] = RF + βA*(RM - RF) = 6% + 1.45*8% = 17.6%

Johnson & Johnson

Beta of Johnson & Johnson = βJ = 0.64

Expected return on Caterpillar = E[RJ] = RF + βJ*(RM - RF) = 6% + 0.64*8% = 11.12%

Consolidated Edison

Beta of Edison = βE = 0.36

Expected return on Edison = E[RE] = RF + βE*(RM - RF) = 6% + 0.36*8% = 8.88%

Answer (in %)

Company Cost of Capital
Caterpillar 20.48
Apple 17.60
Johnson & Johnson 11.12
Consolidated Edison 8.88
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