Question

Problem 12-27 CAPM (LO2) 

The Treasury bill rate is 6%, and the expected return on the market portfolio is 12%. According to the capital asset pricing model: 

a. What is the risk premium on the market? 

b. What is the required return on an investment with a beta of 1.7? (Do not round intermediate calculations. Enter your answer as a percent rounded to 1 decimal place.) 

c. If an investment with a beta of 0.9 offers an expected return of 8.7%, does it have a positive or negative NPV? 

d. If the market expects a return of 11.7% from stock X, what is its beta? (Do not round intermediate calculations. Round your answer to 2 decimal places.) 

Answer 1

As per CAPM

Expected Return = Rf + beta*(Market Risk Premium)

a.

Expected Return = 12%

Rf = 6%

beta = 1 (market portfolio)

Market Risk Premium = (Expected Return - Rf)/beta

Market Risk Premium = (12%-6%)/1 = 6%

b.

beta = 1.7

Rf = 6%

Market Risk Premium = 6%

Expected Return = Rf + beta*(Market Risk Premium)

Expected Return or Return on Investment = 6% + 1.7*6% = 16.2%

c.

Expected Return offered = 8.7%

As per CAPM model

Rf = 6%

beta = 0.9

Market Risk Premium = 6%

Expected Return = 6% + 0.9*(6%)

Expected Return = 11.4%

The Expected Return is higher then Expected Return Offered , therefore NPV will be Negative

d.

Expected Return from stock = 11.7%

Rf = 6%

Market Risk Premium = 6%

Expected Return = Rf + beta*(Market Risk Premium)

11.7% = 6% + beta*(6%)

beta = 5.7%/6% = 0.95