Question

Calculate the expected returns for the stocks of the following companies:

                            Beta              Treasury Bill Return        S&P 500 Return

Adidas                   0.62                     3.9%                    10.7%

       Pepsico         0.36                     3.9%                    10.7%

       Dine Brands        0.56                     3.9%                    10.7%

If the actual returns to these stocks are: Dine Brands 7.71%; Pepsico 8.1%; and Adidas 7.5%, which stock is undervalued, overvalued or correctly valued?

Answer 1

This is a question of practical application of the CAPM formula. We have to calculate the CAPM expected returns of each of the stocks and compare them with the actual returns. If the CAPM theoretical returns are less than the actual returns, then the stock is undervalued and vice versa.

Stock	Beta	T-sec returns	S&P 500 return	CAPM formula	CAPM return	Actual return	Stock valuation
Adidas	0.62	3.90%	10.70%	=3.9%+0.62*(10.7%-3.9%)	8.12%	7.50%	Overpriced/ overvalued
PepsiCo	0.36	3.90%	10.70%	=3.9%+0.36*(10.7%-3.9%)	6.35%	8.10%	Underprice/ undervalued
Dine brands	0.56	3.90%	10.70%	=3.9%+0.56*(10.7%-3.9%)	7.71%	7.71%	Correctly priced/ valued