Please show all work. Thanks in Advance! Albo Corp, a pharma company.has been re

Question

Please show all work. Thanks in Advance!

Albo Corp, a pharma company.has been recently evaluated by financial analysts at Bowden-Frosh. Based on historical performance of the company during the past 5 years, they have concluded that a multi-factor model is a better estimator of the stock's returns. The two independent variables are: S&P500 premium and T-bond portfolio premium Beta associated with the S&P500 1.35 Beta associated with bond portfolio S&P500 risk premium Bond portfolio risk premium 3.5% Risk free rate 2.50% 0.65 8.5% Calculate the expected return on this stock.

Explanation / Answer

Multi Factor Model ( Multi Variate Model)

More than one factor (GNP, inflation etc.) can affect a particular stock and drive the ecpected return from that stock.

Expected Return = Rf + B1*RP1 + B2*RP2+......Bn*RPn

where

Rf - Risk free rate = 2.50%

B1 - Beat of factor 1 = 1.35

B - Beat of factor 2 = .65

RP1 - factor 1 risk premium = 8.50%

RP2 - factor 2 risk premium = 3.50%

Expected Return = 2.50 + 1.35*8.5 + .65*3.5

=2.50+11.475+2.275

= 16.25%

However, the CAPm is more popular because the market/stock index automatically covers all these items.

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