The Capital Asset Pricing Model (CAPM) formula is:

$E(R_i) = R_f + \beta_i \cdot (E(R_m) - R_f)$

Where:

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

Plugging in the values:

• $R_f = 6\%$ or 0.06
• $E(R_m) = 18\%$ or 0.18
• $\beta_i = 1.3$

$E(R_i) = 0.06 + 1.3 \cdot (0.18 - 0.06)$

Step-by-Step Calculation:

1. Calculate the market risk premium: $E(R_m) - R_f = 0.18 - 0.06 = 0.12$
2. Multiply the market risk premium by the beta: $1.3 \cdot 0.12 = 0.156$
3. Add the risk-free rate: $E(R_i) = 0.06 + 0.156 = 0.216 \, \text{or} \, 21.6\%$

Final Answer:

The expected return on the stock is 21.6%.

Would you like a deeper explanation or have any further questions? Here are 5 related questions to expand on this:

1. How does changing the beta affect the expected return?
2. What are the implications of a negative beta in the CAPM?
3. How does the CAPM adjust for changes in market volatility?
4. What is the role of the risk-free rate in portfolio optimization?
5. How does CAPM compare to other models like the Fama-French Three-Factor Model?

Tip: Always ensure the beta used in CAPM reflects the time horizon and context of the investment, as beta can vary with market conditions.