2. Wilson is now evaluating the expected performance of two common stocks, Furhm

Question

2. Wilson is now evaluating the expected performance of two common stocks, Furhman Labs Inc. and Garten Testing Inc. He has gathered the following information: · The risk-free rate is 5%. " The expected return on the market portfolio is 11.5%. The beta of Furhman stock is 1.5. . The beta of Garten stock is.8. on his own analysis, Wilson's forecasts of the returns on the two stocks are 13.25% for Fuh. man stock and 1 1.25% for Garten stock. Calculate the required rate of return for Furman Labs stock and for Garten Testing stock. Indicate whether each stock is undervalued, fairly valued, or overvalued

Explanation / Answer

Solution:

E(r) = rf + × [E(rM) rf]

E(r) = Required rate of return

rf = 5%

E(rM) = Expected Return on Market Poerfolio = 11.5%

of Furhman stock = 1.5

of Furhman stock = 0.8

Fuhrman Labs: E(r) = 5 + 1.5 × [11.5 5.0] = 14.75%

Garten Testing: E(r) = 5 + 0.8 × [11.5 5.0] = 10.20%

Please Note that if the forecast rate of return is less than (greater than) the required rate of return, then the security is overvalued (undervalued).

Fuhrman Labs: Forecast return – Required return = 13.25% 14.75% = 1.50%

Garten Testing: Forecast return – Required return = 11.25% 10.20% = 1.05%

Therefore, Fuhrman Labs is overvalued and Garten Testing is undervalued.

Related Questions

Navigate

• Browse (All)
• Browse 2
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.