If a stock has an 8% expected return, the market return is 10%, the risk free ra

Question

If a stock has an 8% expected return, the market return is 10%, the risk free rate is 3%, and the stock has a beta of 0.7, the stock can be best characterised as:

a.Undervalued; b.Overvalued; c.Fairly Valued; d.Cannot be determined

Based on the solution, the result of the CAPM (Ri=Rf+B (Rm-Rf) is 7.9% thus the answer is: a.Undervalued.

Could somebody please explain why it is considered undervalued? With which number should I compare the 7.9% to get to the conclusion than the stock is undervalued? Thank you

Explanation / Answer

CAPM equation gives expected return over a stock and it's coming out to be 7.9% . So on comparing with market return which is 10%, it's less that's why it's said it's undervalued .

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