The Capital Asset Pricing Model

You are considering an investment in Concordia Utilities and have some questions regarding the income generating abilities of the company.

Concordia Utilities has 4 plants in four states and they all operate as separate entities. All four plants are financed by Concordia and have no holdings of their own, but operate as if they were separate companies. You have gathered some information about the company’s plants as follows:

Table-1:

You have also gathered some information about the market and found that the risk-free rate of interest is 3% and that the company adds a market risk premium of 4% to all investments. The possible market returns and their probabilities are found in Table-2:

Table-2:

Questions:

What is the Beta coefficient for Concordia? Explain your answers.
What is Concordia’s required rate of return on any new investments? Explain your answers.
What is the equation for the Security Market Line (SML)? Show the equation and graph the equation on a graph. Explain what the SML is telling you, and the implications for the firm.
Suppose Concordia has the opportunity to purchase an additional plant. The cost of the new plant will be $200 million and have a beta coefficient of 1.60. If the new plant is expected to return 12%, should Concordia make the investment? Explain your answers and justify your calculations.

Present your analysis of the assigned problems in Excel format. Enter non-numerical responses in the same worksheet using textboxes.

THE CAPITAL ASSET PRICING MODEL

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Case

THE CAPITAL ASSET PRICING MODEL

Assignment Overview

1. For each of the scenarios below, explain whether or not it represents a diversifiable or an undiversifiable risk. Please consider the issues from the viewpoint of investors. Explain your reasoning.

There’s a substantial unexpected increase in inflation.
There’s a major recession in the U.S.
A major lawsuit is filed against one large publicly traded corporation.

Use the CAPM to answer the following questions:

Find the Expected Rate of Return on the Market Portfolio given that the Expected Rate of Return on Asset “i” is 12%, the Risk-Free Rate is 4%, and the Beta (b) for Asset “i” is 1.2.
Find the Risk-Free Rate given that the Expected Rate of Return on Asset “j” is 9%, the Expected Return on the Market Portfolio is 10%, and the Beta (b) for Asset “j” is 0.8.
What do you think the Beta (β) of your portfolio would be if you owned half of all the stocks traded on the major exchanges? Explain.

In one page explain what you think is the main ‘message’ of the Capital Asset Pricing Model to corporations and what is the main message of the CAPM to investors?

Assignment Expectations

The Case report should be a two-page report. Please show your work for quantitative questions.

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