5-Company A stock has a beta of 1.40, and its required return is 12.00%. Company B...

5-Company A stock has a beta of 1.40, and its required return is 12.00%. Company B stock has a beta of 0.80. If the risk-free rate is 4.75%, what is the required rate of return on B's stock?

Expert Solution

Sol:
First we need to determine the market return to calculate the required rate of return on company B's stock.

Company A stock:
Beta=1.4
Required return=12%
Risk free rate=4.75%
We need to use the capital asset pricing model (CAPM) formula to calculate the market return.
Required rate of return=Risk free rate +Beta*(Market return - Risk free rate)
=>12=4.75+1.4*(Market return - 4.75)
=>12=4.75+1.4*Market return - 1.4*4.75
=>12=4.75+1.4*Market return - 6.65
=>12=-1.9+1.4*Market return
=>12+1.9=1.4*Market return
=>13.9/1.4=Market return
=>9.9286=Market return
Hence, market return=9.9286%

We can use this value of market return equal to 9.9286% and CAPM formula to calculate the required rate of return on company B's stock.

Company B stock:
Beta=0.80
Risk free rate=4.75%
Market return=9.9286%
Required rate of return=Risk free rate +Beta*(Market return - Risk free rate)
=4.75%+0.80*(9.9286%-4.75%)
=4.75%+.80*5.1786%
=4.75%+4.14288%
=8.89%
Required rate of return on company B's stock=8.89%

jeff jeffy answered 1 year ago

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