Landon Stevens is evaluating the expected performance of two common stocks, Furh

Question

Landon Stevens is evaluating the expected performance of two common stocks, Furhman Labs, Inc., and Garten Testing, Inc. The risk free rate is 5.7 percent, the expected return on the market is 13.2 percent, and the betas of the two stocks are 1.9 and 0.8, respectively Stevens's own forecasts of the returns on the two stocks are 17.40 percent for Furhman Labs and 11.70 percent for Garten. a. Calculate the required return for each stock. (Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places.) Stock Required Return b. Is each stock undervalued, fairly valued, or overvalued? Furhman Labs Undervalued Fair valued Garten Testing

Explanation / Answer

Required return=risk free+beta*(market return-risk free)

Hence,
required return for Furhman Labs=5.7%+1.9*(13.2%-5.7%)=19.95%
required return for Garten Testing=5.7%+0.8*(13.2%-5.7%)=11.7%

Given,
expected return for Furhman Labs=17.4%
expected return for Garten Testing=11.7%

The stocks whose expected return is more than required return are undervalued and stocks whose expected return is less than required return are overvalued and stocks whose expetced return is equal to required return are fair valued

So,
Furhman Labs is overvalued
Garten Testing is fair valued

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