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Homework answers / question archive / Nikon Company's shares have an expected return of 15
Nikon Company's shares have an expected return of 15.5% and a beta of 1.5. Alpha Company's shares have an expected return of 13.4% and a beta of 1.2. Assume the CAPM holds. What is the expected return on the market?
Computation of the expected return on market:-
Nikon company's shares;
Expected return = Risk free rate + Beta * (Expected market return - Risk free rate)
15.5% = Risk free rate + 1.5 * (Expected market return - Risk free rate).............(i)
Alpha Company's shares;
13.4% = Risk free rate + 1.2 * (Expected market return - Risk free rate).............(ii)
Lets multiply the equation (i) by 4
15.5% = Risk free rate + 1.5 * (Expected market return - Risk free rate) * 4
62% = (4*Risk free rate) + 6 * (Expected market return - Risk free rate)..........(i)
Lets multiply the equation (i) by 5
13.4% = Risk free rate + 1.2 * (Expected market return - Risk free rate) * 5
67% = (5 * Risk free rate) + 6 *(Expected market return - Risk free rate)..........(ii)
Lets subtract the equation (i) from equation (ii) ;
67% - 62% = (5 Risk free rate - 4 Risk free rate) + (6 * (Expected market return - Risk free rate) - (6 * (Expected market return - Risk free rate))
5% = 1 * Risk free rate
Risk free rate = 5%
Lets put the value of risk free rate in equation (i) ;
Expected return = Risk free rate + Beta * (Expected market return - Risk free rate)
15.5% = 5% + 1.5 * (Expected market return - 5%)
(1.5 * Expected return) - 7.5% = 15.5% - 5%
1.5 * Expected market return = 10.5% + 7.5%
Expected market return = 18% / 1.5
= 12%
