Landon Stevens is evaluating the expected performance of two common stocks, Furh
ID: 2727219 • Letter: L
Question
Landon Stevens is evaluating the expected performance of two common stocks, Furhman Labs, Inc., and Garten Testing, Inc. The risk-free rate is 5.4 percent, the expected return on the market is 12.6 percent, and the betas of the two stocks are 1.6 and .8, respectively. Stevens’s own forecasts of the returns on the two stocks are 16.80 percent for Furhman Labs and 11.40 percent for Garten.
Calculate the required return for each stock. (Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places. Omit the "%" sign in your response.)
Landon Stevens is evaluating the expected performance of two common stocks, Furhman Labs, Inc., and Garten Testing, Inc. The risk-free rate is 5.4 percent, the expected return on the market is 12.6 percent, and the betas of the two stocks are 1.6 and .8, respectively. Stevens’s own forecasts of the returns on the two stocks are 16.80 percent for Furhman Labs and 11.40 percent for Garten.
Explanation / Answer
Details Given: Risk Free rate =Rf=5.4% Expected Market vReturn =Rm=12.6% Furhman Labs Beta =1.6 So Required Return Furhman Lab Inc =Rf+(Rm-Rf)*beta =5.4% +(12.6%-5.4%)*1.6 = 16.92% Required return for Furhman Lab Inc=16.92% Garten Testing Inc Beta =0.80 Required Return Gartne Testing =5.4%+(12.6%-5.4%)*0.80 = 11.16% Required return for Garten Inc =11.16% Steven's Own forecast of returns = Furhman Inc=16.8% Garten Testing =11.4% Furhman Estimated return is less than the return as per CAPM So Furhman stock should be overvalued Garten Testing estimated return is more than the erturn as per CAPM So Garten stock is undervalued .
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