CMA Final · Strategic Financial Management · Asset Pricing Theories
The risk-free rate is 6% and the expected return on the market portfolio is 14%. Asha Textiles has an equity beta of 1.25. Using the Capital Asset Pricing Model, the required return on its equity is:
The required return is 16%. Under CAPM it equals the risk-free rate of 6% plus beta of 1.25 times the market premium of 8%, which is 10%, giving 16%. Omitting the risk-free rate would wrongly give 10%.
- A16.0%Correct
- B10.0%
- C17.5%
- D14.0%
Explanation
CAPM: Ke = Rf + beta x (Rm - Rf) = 6% + 1.25 x 8% = 6% + 10% = 16%. The option 10% is only the risk premium (beta x market premium) without adding the risk-free rate. 17.5% wrongly multiplies beta by Rm less nothing (1.25 x 14%).
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