Explanation
According to the Capital Asset Pricing Model (CAPM), the expected return on an asset is given by:
E(Riβ)=Rfβ+(E(Rmβ)βRfβ)Ξ²iβ
Where:
- Rfβ = Risk-free rate = 3%
- (E(Rmβ)βRfβ) = Expected market risk premium = 5%
- Ξ²iβ = Beta for the stock = 1.5
Substituting the values:
E(Riβ)=3%+5%Γ1.5
E(Riβ)=3%+7.5%
E(Riβ)=10.5%
Key Points:
- The expected market risk premium (E(Rmβ)βRfβ) is already given as 5%, so we don't need to calculate it separately
- The beta of 1.5 indicates the stock is 50% more volatile than the market
- The calculation shows Translink's expected return is 10.5% to compensate for its systematic risk