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An analyst has modeled the stock of Crisp Trucking using a two-factor APT model. The riskfree rate is 6%, the expected return on the first factor r1 is 12%, and the expected return on the second factor r2 is 8%. If bi1 0 7 and bi2 0 9, what is Crisp’s required return? Brigham, Eugene F.; Ehrhardt, Michael C.. Financial Management: Theory & Practice (p. 1011). Cengage Learning. Kindle Edition.

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Answer: 12%

Explanation:

Using CAPM, the required return can be found.

required return = risk free rate + beta * market premium

Find the market premium for each factor;

First factor = Expected return - risk free rate

= 12% - 6%

= 6%

Second factor = 8% - 6%

= 2%

In this case each factor has its own beta and market premium so this will have to be accounted for in the CAPM formula as such;

= risk free rate + (beta for r1 * market premium r1) + (beta r2 * market premium r2)

= 6% + (0.7 * 6%) + (0.9 * 2%)

= 12%

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