Question

Partridge Plastic's stock has an estimated beta of 1.4, and its required return is 13%. Cleaver Motors' stock has a beta of 0.8, and the risk-free rate is 6%. What is the required return on Cleaver Motors' stock? a. 7.0% b. 10.4% c. 12.0% d. 11.0% e. 10.0%

Answer 1

Answer:

e. 10.0%

Explanation:

Using the capital asset pricing model we have:

Required return = Rf + beta $\times$ (Rm - Rf)

Where Rf = Risk free return

Rm = Market return

Beta = Beta coefficient

Provided,

Partridge Plastic Stock's information as:

Beta = 1.4

Required return = 13%

Risk free rate = 6%

Putting values in equation, we will get market rate of return

13% = 6% + 1.4 $\times$ (Rm - 6%)

$\frac{0.07}{1.4}$ = Rm - 6%

5% = Rm - 6%

11% = Rm

Now putting this value in equation for information provided for Cleaver Motor's Stock

Required return = 6% + 0.8 $\times$ (11% - 6%)

= 6% + 4%

= 10%