The Capital Asset Pricing Model (CAPM) is a widely used method for estimating the expected return on an asset, taking into account its risk and the expected return on a risk-free asset. The model is based on the idea that investors should be compensated for both the time value of money and the systematic risk they take on investing in an asset.

The CAPM equation is: [E(R_i) = R_f + \beta_i (E(R_m) - R_f)]

Where:

• (E(R_i)) = Expected return on the asset
• (R_f) = Risk-free rate
• (\beta_i) = Beta of the asset
• ((R_m)) = Expected return on the market

Let's consider a case study to illustrate how the CAPM model works:

Case Study: Company X is considering investing in a new project in the automotive industry. The company estimates the risk-free rate to be 2%, the expected return on the market to be 8%, and the beta of the project to be 1.2.

Using the CAPM model, the expected return on the project can be calculated as follows: [E(R_i) = 2% + 1.2*(8% - 2%) = 2% + 7.2% = 9.2%]

So, according to the CAPM model, Company X should expect a return of 9.2% on the new project, taking into account its risk and the overall market conditions.

It's important to note that the CAPM has some assumptions and limitations, such as the efficiency of the market and the validity of beta as a measure of risk. However, it provides a useful framework for understanding the relationship between risk and return in investment decisions.