Your broker has developed a list of firms, their betas, and the return he expects the stock to yield over the next twelve months (labeled "Expected Return"). You have estimated that the risk-free rate is 5% and the return to the market will be 12%. Assuming that CAPM is correct, which stock should you purchase? Firm Beta Expected Return Anderson, Inc. 0.90 10.5% Delta Vanlines 1.24 13.0% Nathan's Bakeries 1.50 16.0% Z-man Electronics 2.15 19.0%

I would purchase stocks from Nathan's Bakeries which is above their cost of capital according to CAPM

Explanation:

We will purchasethe stock based on the CAPM cost of capital to know if the expected return is above or equal to CAPM.

risk free =0.05

market rate =0.12

premium market = (market rate - risk free)0.07

Anderson, Inc.

beta(non diversifiable risk) =0.9

Ke0.11300 = 11.30%

Expected return 10.5%

NO as it is lower than CAPM

Delta Vanlines

beta(non diversifiable risk) =1.24

Ke0.13680 = 13.68%

return 13%

NO as it is lower than CAPM

Nathan's Bakeries

beta(non diversifiable risk) =1.5

Ke0.15500 = 15.50%

return 16%

YES as it is hihger than CAPM

Z-man Electronics

beta(non diversifiable risk) =2.15

Ke0.20050 = 20.05%

return 19%

NO as it is lower than CAPM

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