Question

Using the Capital Asset Pricing Model *(CAPM) and the Betas from the table below, along with market parameters shown below, what is the required return for Ford Motor Co.? (round your answer to two decimal places)

Company Beta

US Steel 1.77

Ford Mo Co 1.31

General Electric 1.20

Boeing   0.94

Amazon   0.90

Starbucks 0.79

McDonalds 0.51  

Walmart 0.26

Market Details

Current T-Bill Price 985.12

Historic Average T-Bill Return 2.3%

Current Market Return 8.5%

Historic Average Market Return   8.9%

B) Review the table below. Beta is a measure of sensitivity, showing how the returns of an individual investment compare to the returns of the Market as a whole. Beta is measured by analyzing actual historic Market returns. Starbucks sells coffee. What might explain why a company like Starbucks has its Beta at that level ?  

Answer 1

Capital Asset Pricing model helps in understanding the relationship between the market risk & the expected return from an asset (generally stock). It is in general used to price the securities given the market risk & cost of capital.

Formula to compute expected return using CAPM is as below:

ERi (Expected return on Investment) = Risk free rate + Beta (risk) of Investment * (Market risk Premium)

Market Risk premium = Expected Return from Market - Risk free Rate

The required return for Ford Market Co is :-

Beta - 1.31

If the stock is risker than the market it will have a beta greater than 1.

Expected Return = 2.3 + 1.31 *(8.9-2.3)

= 10.95

Therefore, the required or expected return for Ford Market Co = 985.12*10.95%

= 107.87 per stock.

(B)

The starbucks beta level is at 0.69. This is less than 1, which indicates the price fluctuation against market is by .69 % only. If NIFT or Sensex Increases or decreases the starbucks stock value will have less impact, i.e the proportion of increase or decrease in price will be less compared to market. Such stocks are less risk stocks in the portfolio. Lesser the risk, return would also be less.

Beta level is below 1 for the reason that coffee business wont depend on the market situation. It is more largely going to be the same as it's is independent of market situations.