Question

Last year, Rocket Inc. earned a % return. Farmer's Corp. earned %. The overall market return last year was %, and the risk-free rate was %. If Rocket stock has a beta of and Farmer's has a beta of , which stock performed better once you take risk into account? 19 12 16 3 1.9 0.5 Click the icon to see the Worked Solution. Rocket's expected return is %. (Enter as a percentage and round to one decimal place.) Farmer's expected return is %. (Enter as a percentage and round to one decimal place.) Which stock performed better once you take risk into account? (Select the best answer below.)

Answer 1

Answer:

a) Expected Return for Rocket Inc. = 27.7 %

b) Expected Return for Farmer's Corp. = 9.5 %

c) The Stock performed better once you take risk into account = Rocket Inc.

Explanation:

Given - Last year, Rocket Inc. earned a 19 % return. Farmer's Corp. earned 12 %. The overall market return last year was 16 %, and the risk-free rate was 3 %. If Rocket stock has a beta of 1.9 and Farmer's has a beta of 0.5.

To find - (a) Rocket's expected return is ... ?

               (b) Farmer's expected return is ... ?

                (c) Which stock performed better once you take risk into account ?

Solution -

The formula for Expected return is -

Expected Return = Risk-free rate + Systematic Risk ( Market Return - Risk-free rate )

a)

Now,

For Rocket Inc. -

Expected Return = 3% + 1.9 ( 16% - 3% )

                            = 3% + 1.9 (13 %)

                            =  3% + 24.7 %

                            = 27.7 %

⇒Expected Return for Rocket Inc. = 27.7 %

b)

For Farmer's Corp. -

Expected Return = 3% + 0.5 ( 16% - 3% )

                            = 3% + 0.5 (13 %)

                            =  3% + 6.5 %

                            = 9.5 %

⇒Expected Return for Farmer's Corp. = 9.5 %

c)

Now,

Given that,

Actual Return of Rocket Inc. = 19 %

Expected Return of Rocket Inc. = 27.7 %

⇒ Performance is better

Now,

Actual Return of Farmer's Corp.  = 12 %

Expected Return of Farmer's Corp.  = 9.5 %

⇒ Performance is worst

∴ we get

The Stock performed better once you take risk into account = Rocket Inc.