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Hi Sir,
Can you please advice on the question below please.
As part of the senior team of G plc, you have been asked to evaluate three listed companies in which G has a minority shareholding. None of these are considered to be trade investments but are held purely on a speculative basis.
You have calculated the following figures concerning the three investments:
Investment A B C
Equity beta 1.24 0.78 1.02
Actual annual return (%) 12.16 12.20 13.09The market risk premium on the market portfolio is expected to be 8% and the risk-free rate 5%.
Based on your analysis, which of the above investments would you advise G to sell?
Thanks
I tried using the CAPM formula
rf+(rf-rm)Betaand for A I got 8.72% by doing the below calculation
5%+(8%-3%)*1.24
using the same formula and adjusting for beta to calculate the below as:
b= 7.34%
c=8.06%But not sure what to do next?
Compare the actual returns with those ‘predicted’ using CAPM.
However the CAPM returns that you have calculated are not correct. 8% is not the market return – it is the market premium (and so the market return is 13% (8 + 5))
If they are actually giving a return that is currently lower than that predicted using CAPM then those would be the ones to sell, because it would mean that their share price will be higher at the moment than it will be in the future.
ahh I misread the question and did not see that it said premium. so no need to take the difference between Rf and Rm.. which is what I was meant to show as 8%-5%.. no need to deduct since 8% is the premium!
I will rework.
Thanks Sir
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