Question

A few years ago, the Value Line Investment Survey reported the following market betas for the stocks of selected healthcare providers: Company Beta Quorum Health Group 0.90 Beverly Enterprises 1.20 HEALTHSOUTH Corporation 1.45 United Healthcare 1.70 At the time these betas were developed, reasonable estimates for the risk-free rate, RF, and the required rate of return on the market, R(Rm), were 6.5 percent and 13.5 percent, respectively. a. What are the required rates of return on the four stocks? b. Why do their required rates of return differ? c. Suppose that a person is planning to invest in only one stock rather than hold a well-diversified stock portfolio. Are the required rates of return calculated above applicable to the investment? Explain your answer.

Answer 1

a.

Company	Risk free rate	Market Return	Beta	CAPM Working	Expected return
Stocks	Rf	Rm	B	Ri = Rf+B*(Rm-Rf)	Ri = Rf+B*(Rm-Rf)
Quorum Health Group	6.50%	13.50%	0.90	=6.5%+0.90*(13.5%-6.5%)	12.80%
Beverly Enterprises	6.50%	13.50%	1.20	=6.5%+1.2*(13.5%-6.5%)	14.90%
HEALTHSOUTH Corporation	6.50%	13.50%	1.45	=6.5%+1.45*(13.5%-6.5%)	16.65%
United Healthcare	6.50%	13.50%	1.70	=6.5%+1.7*(13.5%-6.5%)	18.40%

b.

Each stock has different beta which is measure of risk they bear hence stocks have different return from each other. Beta is multiplier of market risk premium i.e. Rm-Rf

c.

Person planning to invest in one stock will earn return on that stock. The applicable rate would be the return on particular stock in which he or she invests.

Note: c. part of the question is not very clear as it is subjective in nature.