# Assignment on CAPM (Capital Asset Pricing Model)

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Question 1-Part a
CAPM
Expected Return = Risk free Rate + Beta * (Expected Market Return- Risk Free Rate)
If expected return CAPM is greater Investors Return, then share is overpriced.
If expected return CAPM is Investors Return, then share is underpriced.
If expected return CAPM is equal to Investors Return, then share is overpriced
Share Beta Investors Return CAPM
A 1.5 14% 11% Underpriced
B 0.6 8% 6% Underpriced
C 1.2 9% 9% Correctly priced
D 1.8 10% 12% Overpriced
Part b
Need to construct a portfolio such that Wa *14% + (1-Wa) *8%≥ 10%
Wa = 33.33%. Therefore construct a portfolio with at least 33.3% shares A
Part c -e
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B C D E
Year ProjectA ProjectB ProjectC
0 -20000 -40000 -70000
1 18000 5000 30000
2 18000 10000 30000
3 18000 30000 40000
4 80000 50000
5 100000 180000
NPV =C4+NPV(\$D\$1,C5:C9) =D4+NPV(\$D\$1,D5:D9) =E4+NPV(\$D\$1,E5:E9)
IRR =IRR(C4:C8,10%) =IRR(D4:D9,30%) =IRR(E4:E9,50%)
ProfitabilityIndex =NPV(\$D\$1,C5:C9)/-C4 =NPV(\$D\$1,D5:D9)/-D4 =NPV(\$D\$1,E5:E9)/-E4
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B C D E
Year Project A ProjectB ProjectC
0 (20,000) (40,000) (70,000)
1 18,000 5,000 30,000
2 18,000 10,000 30,000
3 18,000 30,000 40,000
4 80,000 50,000
5 100,000 180,000
NPV 23,233 101,374 143,085
IRR 72.45% 55.51% 56.01%
ProfitabilityIndex 2.16 3.53 3.04
c. Net Present Value
Project C has the highest NPV-143,085, therefore it is the best. It is then followed by
project B with NPV -101,374 ,and lastly project A with NPV -23,233.
d. Payback Period
PBP A = 20,000/18,000 = 1.11
PBP B= 2 + (40,000-15,000)/30,000 = 2.83
PBP C= 2 + (70,000-60,000)/40,000 = 2.25
We observe Projects A and C have a payback period less than acceptance criteria 2.75,
therefore Sharpe should accept both Project A and project C..
e.IRR and Profitability index
IRR is the rate or return that NPV = 0
Profitability Index = PV of future cash flows/initial investment
A –IRR- 72.45% and PI- 2.16
B- IRR- 55.51% and PI- 3.53
C- IRR- 56.01% and PI- 3.04
Question 2
Part a
i.20 year Loan Term
The Loan Sam will borrow is 630,000 (90% *700,000)
PV= 630,000
i= 3.5% pa
n=20 years
Annual Payments, PMT=?
We need to compute PMT using annuity formula below
PV = PMT*( 1(1+i ¿¿¿n)
i )
630,000= PMT*( 1(1+3.5 % ¿¿¿20)
3.5 % )
Solve PMT
PMT = 44,327.478
ii.25 year Loan Term
The Loan Sam will borrow is 630,000 (0.9*700,000)
PV= 630,000
i= 3.5% pa
n=25 years
Annual Payments, PMT=?
We need to compute PMT using annuity formula below
PV = PMT*( 1(1+i ¿¿¿n)
i )
630,000= PMT*( 1(1+3.5 % ¿¿¿25)
3.5 % )
Solve PMT= 38,224.642

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