Question

A manager believes his firm will earn a 14 percent return next year. His firm has a beta of 1.2, the expected return on the market is 11 percent, and the risk-free rate is 5 percent. Compute the return the firm should earn given its level of risk. (Round your answer to 2 decimal places.)

Answer 1

Answer:

r = 0.122 or 12.2%

Explanation:

Using the CAPM, we can calculate the required/expected rate of return on a stock. This is the minimum return required by the investors to invest in a stock based on its systematic risk, the market's risk premium and the risk free rate.  

The formula for required rate of return under CAPM is,

r = rRF + Beta * (rM - rRF)

Where,

• rRF is the risk free rate

• rM is the market return

r = 0.05  +  1.2 * (0.11 - 0.05)

r = 0.122 or 12.2%