Question

Parr Paper's stock has a beta of 1.442, and its required return is 13.00%. Clover Dairy's stock has a beta of 0.80. If the risk-free rate is 4.00%, what is the required rate of return on Clover's stock?

Answer 1

Answer:

Required rate of return on clover's stock is 8.99%

Explanation:

The required rate of return on Clover's stock can be computed using Miller and Modgliani capital asset pricing model formula given below:

Ke=Rf+beta*(Rm-Rf)

Ke is the required rate of return, the unknown

Rf is the risk free rate of return of 4.00%

beta for Clover is 0.80

Rm is the not known as well but can computed using the Parr paper's details below:

beta is 1.442

required return IS 13%

13.00%=4.00%+1.442*(Rm-4.00%)

13%-4%=1.442*(Rm-4.00%)

9%=1.442*(Rm-4.00%)

9%/1.442=Rm-4%

6.24% =Rm-4%

Rm=6.24%+4%

Rm=10.24%

Now the required return on Clover's stock can be computed

Ke=4%+0.8*(10.24%-4%)

Ke=8.99%