CAPM is useful for capital budgeting in light of these shortcomings; it concludes that even given the anomalies cited, the model still can be useful to managers who wish to increase the fundamental value of their firms. Yet another use of the CAPM is in utility rate-making cases.11 In this case the issue is the rate of return that a regulated utility should be allowed to earn on its investment in plant and equipment. Suppose that the equityholders have invested $100 million in the firm and that the beta of the equity is .6. If the T-bill rate is 6% and the market risk premium is 8%, then the fair profits to the firm would be assessed as 6 .6(8) 10.8% of the $100 mil- lion investment, or $10.8 million. The firm would be allowed to set prices at a level ex- pected to generate these profits.           CONCEPT C H E C K ☞ QUESTION 4 and QUESTION 5 Stock XYZ has an expected return of 12% and risk of 1. Stock ABC has expected return of 13% and 1.5. The markets expected return is 11%, and rf 5%. a. According to the CAPM, which stock is a better buy? b. What is the alpha of each stock? Plot the SML and each stocks risk-return point on one graph. Show the alphas graphically.   The risk-free rate is 8% and the expected return on the market portfolio is 16%. A firm considers a project that is expected to have a beta of 1.3. a. What is the required rate of return on the project? b. If the expected IRR of the project is 19%, should it be accepted?         11 This application is fast disappearing, as many states are in the process of deregulating their public utilities and allowing a far greater degree of free market pricing. Nevertheless, a considerable amount of rate setting still takes place.