Capital Asset Pricing Model.
Select two companies with publicly traded securities. One company should be one you consider "high-risk" and one company should be one you consider "low-risk". The companies do not have to be in the same industry (for this small experiment to work well they should probably not be in the same industry). Assume an equity market risk premium of 3%. Search in current business press (i.e. Wall Street Journal, Yahoo!Finance, Bloomberg, etc) and find the current risk-free rate of return (either the current rate on 3 month U.S. T-Bills or 10-year U.S. Government bonds) and the Beta for each security. Use these pieces of information to calculate the CAPM expected return of the two securities. In the initial post show your calculation of the CAPM expected return of each of the two securities and discuss the reasons for the difference in expected returns and the implications of the differences in expected returns. Also in your first post, discuss the issues and weaknesses of one of the four key assumptions underlying the CAPM (see O’Brien & Scott page 136, section 4.5.2) pertaining to the two companies you chose. In your response posts try and choose a classmate whose two stocks are in different industries to what you selected for your first post. In each of your three response posts be sure to cite at least one additional academic citation on the topic of the CAPM (i.e. the use of CAPM and its limitations. There are many prior papers on the topic. Papers published in the last ten years will be most interesting).
All dialogues should follow the Doctoral Business Dialogue Guidelines, posted on Canvas. The guidelines indicate each post should be between 250 and 300 words, excluding references. The guidelines also note only posts made during the two-week period will be graded.
INSTRUCTIONS
Peer reply 1Diana Borrego
Jun 4 3:57pm| Last reply Jun 6 7:13amManage Discussion by Diana BorregoReply from Diana Borrego
DB 3 Capitol Asset Pricing Model
The Capital Asset Pricing Model (CAPM) is an economic model that helps investors determine the risk-free rate of return on the stocks they purchase. Berk and DeMarzo (2024) and Scott and O'Brien (2020) state that the CAPM can help an investor understand the risk they are undertaking by purchasing a stock.
The CAPM formula is:
Risk Free Rate = rf (10-year US Treasury Bond) 4.40% (May 2025)
Equity rate of return 3%
Beta= B
Equity market risk premium 3%
Expected return (E[r])=rf+B* 4.40*(RM-rf)
The two Companies I chose to analyze are McDonald's (MCD) low and Dutch Bros Coffee (BROS) high.
The CAPM equation for McDonald's (MCD) is
(E[r])=4.40%
Beta 0.56% (Yahoo Finance, 2025)
rf=3%
The expected return is 3.78%. Low
The CAPM equation for Dutch Bros (BROS)
(E[r])=4.40%
Beta 2.75%(Yahoo Finance2025)
rf= 3%
The expected return is 6.85%. High
Hanlon, Yeung, and Zuo (2022) explain that behavioral theory can provide shareholders with either the right or wrong insight into the stocks they hold, depending on how top management operates, the type of behavior investors exhibit, and how well the calculations are executed. (Hanlon, et al. 2022).
Upon reviewing the CAPM calculations, we can see that the best long-term stock is McDonald's, with a lower risk of 3.78%. At the same time, Dutch BROS Coffee's CAPM calculation is 6.85%, which is considered a higher risk stock.
With the Markets rising or falling daily, the CAPM calculations can be correct one day and incorrect the next.
References
Berk and DeMarzo, (2024) Corporate Finance, 6th ed. Pearson Publications
Hanlon, M., Yeung, K., & Zuo, L. (2022). Behavioral economics of Accounting: A review of Archival Research on Individual Decision Makers. Contemporary Accounting Research 39 (2), 1150-1214
Scott, W.R. and O'Brien, P. C., (2020) Financial Accounting Theory, 8th ed. Pearson Publications
US Treasury (2025) 10-year Treasury Bond. https.//www.hometreasuary.gov
Yahoo Finance, (2025) Dutch Bros Coffee, (BROS), and McDonald's (MCD) https://financial.yahoo.com
LaShawn Doolittle-peer reply 2
May 26 12:18pm| Last reply Jun 5 11:51amManage Discussion by LaShawn DoolittleReply from LaShawn DoolittleHere’s a model initial post based on your prompt for the Capital Asset Pricing Model (CAPM) assignment. This example includes CAPM calculations for a high-risk and a low-risk company, a discussion of their expected returns, and an evaluation of one of the CAPM assumptions:
CAPM Expected Return Analysis: High-Risk vs. Low-Risk Securities
For this exercise, I selected two publicly traded companies from distinct industries: Rivian Automotive, Inc. (RIVN) as the high-risk firm, and Johnson & Johnson (JNJ) as the low-risk firm. Rivian, a relatively new EV company, faces high volatility and uncertain profitability. In contrast, Johnson & Johnson is a well-established healthcare conglomerate with a history of stable earnings.
Assumptions for CAPM Calculation:
Risk-Free Rate (10-Year U.S. Treasury Bond): 4.40% (as of May 2025, source: U.S. Treasury/Yahoo Finance)
Equity Market Risk Premium: 3%
CAPM Formula:Expected Return (E[R]) = Rf + β × (Rm – Rf)
1. Rivian Automotive (RIVN) – High Risk
Beta (β): 2.10 (Yahoo Finance, 2025)
CAPM:E[R] = 4.40% + 2.10 × 3% = 10.70%
2. Johnson & Johnson (JNJ) – Low Risk
Beta (β): 0.55 (Yahoo Finance, 2025)
CAPM:E[R] = 4.40% + 0.55 × 3% = 6.05%
Discussion of Differences
The significant variance in expected returns—10.70% for Rivian vs. 6.05% for Johnson & Johnson—is largely driven by the beta coefficient, which reflects each stock's volatility relative to the market. Rivian’s high beta reflects its vulnerability to market swings, uncertainty in revenue, and industry competition. Conversely, JNJ’s lower beta stems from its resilient, diversified product base in the essential healthcare sector.
The implication is clear: investors require higher expected returns to compensate for greater risk. While high-beta stocks may promise higher returns, they are more sensitive to macroeconomic downturns and market volatility.
CAPM Assumption Weakness: Rational Investors
One of CAPM’s key assumptions is that all investors behave rationally and seek to maximize utility. However, behavioral finance research contradicts this notion. Investors frequently display biases such as overconfidence, loss aversion, and herd behavior (Barberis & Thaler, 2003). In the case of Rivian, irrational exuberance and speculative hype have often inflated its stock price, regardless of underlying fundamentals—suggesting that real-world investor behavior diverges significantly from the model's assumptions.
ReferencesBarberis, N., & Thaler, R. (2003). A survey of behavioral finance. Handbook of the Economics of Finance, 1, 1053–1128. https://doi.org/10.1016/S1574-0102(03)01027-6Berk, J., & DeMarzo, P. (2023). Corporate Finance (6th ed.). Pearson.O’Brien, T., & Scott, J. (2020). Financial Management for Faith-Based Organizations. Routledge.Yahoo Finance. (2025). Rivian Automotive, Inc. (RIVN) and Johnson & Johnson (JNJ). https://finance.yahoo.comLinks to an external site.U.S. Department of the Treasury. (2025). Daily Treasury Yield Curve Rates. https://home.treasury.gov/