Answer:
The Return On Assets of the business is 0.1956, approximately 0.20 to two decimal places and without entering the percentage sign.
With the percentage sign, it would be 19.56% approximately 20%
Explanation:
Using the CAPM (Capital Asset Pricing Model) which explains the relationship between expected return on assets and systematic risk,
The formula for Expected Return On Assets is:
ERA = RFR + BOA (MRP)
where ERA = expected return on assets
RFR = risk-free rate
BOA = beta of the asset
MRP = market risk premium
First, we need to get the BOA
In the absence of tax rate, the BOA is = (BOE × DTER) ÷ BOD
where BOE = beta of equity
DTER = debt-equity ratio or debt to equity ratio
BOD = beta of debt
BOA = (2.33 × 0.35) ÷ 0.3
= 0.8155 ÷ 0.3 = 2.7183
Now, ERA = 3.25% + 2.7183 (6%)
ERA = 0.0325 + 2.7183 (0.06)
ERA = 0.0325 + 0.1631
ERA = 0.1956 approximately 0.20 to two decimal places.
Answer:
14%
Explanation:
Capital asset pricing model measure the expected return on an asset or investment. it is used to make decision for addition of specific investment in a well diversified portfolio.
Formula for CAPM
Expected return = Risk free rate + beta ( market risk premium )
First we need asset beta to calculate the rate of return.
If Debt to equity ratio is 35% then the equity is 100%.
Debt to equity ratio = 35% = 0.35
Beta(asset) = (2.33 x 1/1.35) + ( 0.3 x 0.35/1.35)
Beta(asset) = 1.73 + 0.08 = 1.81 = 1.8
Now place values in the CAPM formula
Required Rate of return = 3.25% + 1.8 x (6%) = 14.05%
