As an equity analyst you are concerned with what will happen to the required ret
ID: 2710763 • Letter: A
Question
As an equity analyst you are concerned with what will happen to the required return to Universal Toddler Industries stock as market conditions change. Suppose rRF=5% rM =12% and bUTI = 1.4
A. Under the current conditions what is rUTI, the required rate of return on UTI Stock?
B. Now suppose rFR (1) increases to 6% or (2) decreases to 4%. The slope of the SMI remains constant. How would this affect rM and rUTI?
C. Now assume rFR remains at 5% but rM (1) increases to 14% or (2) falls to 11%. The slope of the SML does not remain constant. How would these changes affect rUTI?
YOU MUST SHOW ALL WORK IN DETAIL AND FORMULAS
Explanation / Answer
= 0.05 + 1.4(0.12-0.05)
= 14.80%
The market risk premium = (0.12-0.05) = 0.07
= 0.06 + 1.4 * 0.07
= 15.80%
ii. rRF = 4% with constant SML
= 0.04 + 1.4 * 0.07
= 13.80%
= 0.05 + 1.40(0.14-0.05)
= 17.60%
ii. rM decreases to 11%
= 0.05 + 1.40(0.11-0.05)
= 13.40%
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