Question

A. Assume that the risk-free rate is 8 percent, the required rate of return on the market (or an average-risk stock) is 13 percent, and the required rate of return on Acme Healthcare stock is 15 percent. What is the implied beta coefficient of the stock?
b. Assume the risk free rate is 4 percent, the required rate of return on the market portfolio is 15 percent, and the reported beta for a medical device manufacturer is 1.7. Calculate the required rate of return on the stock of the medical device manufacturer under the capital asset pricing model

Answer 1

Answer:

a. Rf = 8%

Rm = 13%

Ke = 15%

β = ?

Ke = Rf  + β(Rm – Rf)

15 = 8  + β(13 - 8)

15 = 8 + β(5)

15 - 8 = 5β

7 = 5β

β = 7/5

β = 1.4

b. Ke = Rf  + β(Rm – Rf)

   Ke = 4 + 1.7(15 - 4)

   Ke = 4 + 1.7(11)

   Ke = 4 + 18.7

   Ke = 22.7%

Explanation:

In the first part of the question, there is need to calculate beta using capital asset pricing model. Risk-free rate, market return and required return on stock were given with the exception of beta. Thus, we will make beta the subject of the formula.

In the b part of the question, we need to calculate the required return on the stock given the risk-free rate, beta and market return. Therefore, we will apply the capital asset pricing model to calculate the required return.