Question

Maynard Crabbes has determined the expected return on the market portfolio at 17% and a 5% return on the risk-free security when examining Anstell Ltd. shares for possible additional investment, given that he has been acquiring shares in the company each year for the last 4 years. From plotting historical returns he has assessed that returns for Anstell Ltd. have outperformed or underperformed the market on average by a factor of 1.7.

Required:

(1) What is the company’s risk-adjusted rate of return?

(2) Given that Maynard has forecast next years return for Anstell Ltd. shares to be 20%, should he be deciding to; hold, buy or sell shares in the company?

(3) Based on your prior discussion, are the company shares currently undervalued, overvalued, or correctly valued?

Answer 1

1.

Using CAPM model,

Required Rate = 0.05 + 1.70(0.17 - 0.05) = 25.40%

2.

One should sell the shares as forecasted return is less than required return on stock

3.

As forecasted return is less than required return on stock, stock is overvalued