You, as the equity analyst, are concerned with what will happen to the required

Question

You, as the equity analyst, are concerned with what will happen to the required return to Toad Corporation's stock as market conditions change. Suppose rRF = 5%, rM = 9%, and bUTI = 1.8.

What is rUTI, the required rate of return on UTI Stock? Round your answer to two decimal places.

Now suppose rRF increases to 6%. The slope of the SML remains constant. How would this affect rM and rUTI? Select One from below:

I. Both rM and rUTI will increase by 1%.
II. rM will remain the same and rUTI will increase by 1%.
III. rM will increase by 1% and rUTI will remain the same.
IV. Both rM and rUTI will decrease by 1%.
V. Both rM and rUTI will remain the same.

Suppose rRF decreases to 4%. The slope of the SML remains constant. How would this affect rM and rUTI? Select one from below:

I. rM will decrease by 1% and rUTI will remain the same.
II. rM will remain the same and rUTI will decrease by 1%.
III. Both rM and rUTI will increase by 1%.
IV. Both rM and rUTI will remain the same.
V. Both rM and rUTI will decrease by 1%

Now assume rRF remains at 5% but rM increases to 11%. The slope of the SML does not remain constant. How would these changes affect rUTI? Select One from below:

I. rUTI will decrease by 3.6%.
II. rUTI will remain the same.
III. rUTI will increase by 3.6%.

Assume rRF remains at 5% but rM falls 8%. The slope of the SML does not remain constant. How would these changes affect rUTI? Select One from below:

I. rUTI will remain the same.
II. rUTI will decrease by 1.8%.
III. rUTI will increase by 1.8%.

Explanation / Answer

Forulas to be use: Required return = Rf + (Rm - Rf) x Beta
Rm - Rf = Risk premium = Slope of SML

a. rUTI = 5 + (9 - 5) x 1.8 = 12.20%

b. Slope is same as previous. Thus, Rm-Rf = 4%. This means rM is also increasing by 1%
rUTI = 6 + 4 x 1.8 = 13.20%
Thus, both rM and rUTI is inreasing by 1%. Thus, Option I.

c. Same as previous (b), this time the rF is decreasing thus, rM and rUTI will decrease by 1%. Thus, Option V.

d. rUTI = 5 + (11 - 5) x 1.8 = 15.80%
Increase in return = 15.80 - 12.20 = 3.60%.Thus, Option III.

e. rUTI = 5 + (8 - 5) x 1.8 = 10.40%
Decrease in return = 12.20 - 10.40 = 1.80%.Thus, Option II.

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