Question

Dee's Fashions has a growth rate of 5.2 percent and is equally as risky as the market while its stock is currently selling for $28 a share. The overall stock market has a return of 12.6 percent and a risk premium of 8.7 percent. What is the expected rate of return on this stock?

Answer 1

Answer:

12.6%

Explanation:

Using the Capital Market Pricing Model (CAPM) to compute the expected rate of return on Dee's Fashion stock.

Expected rate of return = $R_{f} +\beta (R_{m} -R_{f} )$

Where R(f) = risk free rate of return, or market return less risk premium = 12.6% - 8.7% = 3.9%

$\beta$ = the risk of the stock relative to the market risk. In this case, beta = 1, since the company is equally as risky as the market (as noted in the question)

R(m) = return of the stock market = 12.6%

Therefore, the expected rate of return on the stock

= 3.9% + 1 * (12.6% - 3.9%)

= 3.9% + 8.7%

= 12.6%.

The return is the same as the stock market return because the stock is equally as risky as the market.