CAPM: You are given the following information about a company. Its current value

Question

CAPM: You are given the following information about a company. Its current value in the stock market is $255 Million. The stock’s volatility (i.e., the standard deviation of its return) is 40% per year, and the correlation between its returns and the return on the market is 0.6.

The one-year risk free rate is 3% and the market’s risk premium is 6%. The volatility of the market’s return is 15% per year.

a. What is the company’s beta?

b. What is the company’s expected returns?

c. What is the company expected to be worth a year from now?

Explanation / Answer

(a) Beta = (Correlation b/w stock & market return x Stock volatility) / Market volatility

= (0.6 x 40%) / 15% = 1.6

(b) Expected return = Risk-free rate + Beta x Market risk premium

= 3% + 1.6 x 6%

= 3% + 9.6%

= 12.6%

(c) Expected value = $255 million x 1.126 = $287.13 million

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