Question

Suppose two factors are identified for the U.S. economy: the growth rate of industrial production, IP, and the inflation rate, IR. IP is expected to be 4% and IR 5%. A stock with a beta of 1 on IP and 0.6 on IR currently is expected to provide a rate of return of 16%. If industrial production actually grows by 5%, while the inflation rate turns out to be 6%, what is your best guess for the rate of return on the stock? (Round your answer to 1 decimal place.)

Answer 1

Answer:

17.6%

Explanation:

According to the scenario, computation of the given data are as follow:-

We can calculate the rate of return on the stock by using following formula:-

Expected Provide Rate of Return = Estimate Rate of Return on the Stock + (Expected IP × Stock with a Beta on IP) + (Expected IR × Stock with a Beta on IR)

Before estimate rate of return on the stock

= 16% = α + (4% × 1) + (5% × 0.6)

= 16% = α + (0.04 × 1) + (0.05 × 0.6)

= 0.16 = α + 0.04 + 0.03

= 0.16 - 0.04 - 0.03 = α

α = 0.09 =9%

Rate of return after the changes

= 9% + (5% × 1) + (6% × 0.6)

= 0.09 + 0.05 + 0.036

= 0.176

= 17.6%

According to the analysis, New rate of return on the stock is 17.6%