A) Landon Stevens is evaluating the expected performance of two common stocks, F

Question

A) Landon Stevens is evaluating the expected performance of two common stocks, Furhman Labs, Inc., and Garten Testing, Inc. The risk-free rate is 5.1 percent, the expected return on the market is 12.0 percent, and the betas of the two stocks are 1.3 and .8, respectively. Stevens’s own forecasts of the returns on the two stocks are 16.20 percent for Furhman Labs and 11.10 percent for Garten. 1. 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.)

Stock Required Return Furhman Labs %

Garten Testing %

Assume these securities are correctly priced. Based on the CAPM, what is the expected return on the market? What is the risk-free rate? (Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places. Omit the "%" sign in your response.)

Explanation / Answer

A) Stock Required Return Furhman Labs = 5.1% + 1.3 * (12% - 5.1%)

= 14.07%

Stock Required Return Garten Testing = 5.1% + 0.8 * (12% - 5.1%)

= 10.62%

B) Let expected return on market be "M" and risk free rate be "R".

Therefore, 13.4% = R + 1.6 * (M - R)

=> 1.6 * M - 0.6 * R = 13.4%-------------------------- (i)

And, 10.7% = R + 0.85 * (M - R)

=> 0.85 * M + 0.15 * R = 10.7%----------------------- (ii)

Now, 0.15 * (i) + 0.6 * (ii) gives

0.75 * M = 8.43%

=> M = 11.24%

Therefore, (i) => 1.6 * 11.24% - 0.6 * R = 13.4%

=> R = 7.64%

Related Questions

Navigate

• Browse (All)
• Browse A
• Subjects

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