Case Study Of The Capital Asset Pricing Model

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Register to read the introduction… From the information provided in the case, we were informed that the current government bond yields were 5.09% on 90-day treasury bills, 5.79% on 5-year bonds, 5.91% on 10-year bonds and 6.22% on 30-year bonds. We were also given that by definition the market had a β of 1.0, less risky stocks have β < 1.0 and more risky stocks have β > 1.0. Lastly, we were told that Jessie noted that the historical market risk premium (Rm – Rf) was in the 6% range. The equation used to approximate the investor's required rate of return is: r = Rf+ β (Rm-Rf)
Rf represents the risk-free return, which U.S Treasury bills are usually the proxy used. β represents the beta, which is used to measure risk associated with stocks: The adjusted β of 1.24 was used because it takes into consideration an estimation of future β’s rather than just historical which is what the raw β is based on.
Rm represents the market return, which can be based on past returns or future returns or from the S&P 500 index.
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D1= .62 r = .1941 g = .12
P0 = .62 / (.1941-.12)
P0 = $8.37
Price/Earnings Multiple
Price/ Earnings Ratio or P/E ratio is a ratio that is widely used in investment industries because it is commonly available and easily used for comparative purposes. Generally, firms with better growth prospects and/or lower risk command higher multiples. The case stated that Coca Cola currently traded at a P/E ratio of 35x.
P/E Ratio =price per shareEPS
EPS: income available to common shareholdersSHROUT EPS: obtained from exhibit 4, the 1997 estimate.
Income available to common shareholders: Net income-Preferred dividends
Price per share = $58 EPS = $1.70
P/E Ratio = $58 / $1.70
P/E Ratio = $34.12

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