Question

Suppose, based on the earnings consensus of stock analysts, Brandon expects a return of 6.85% from the portfolio with the new weights. Does he think that the required return as compared to expected returns is undervalued, overvalued, or fairly valued?

Answer 1

Answer:

a. 0.4840 percentage points

b. Project is overvalued

c. Required return from the portfolio would increase.

Explanation:

Note: The full question is attached as picture

New Allocation on Transfer Fuels corporation = 30%+35%

New Allocation on Transfer Fuels corporation = 65%

Beta after the new allocation = (20%*1.50) + (15%*1.10) + (65%*0.5)

Beta after the new allocation = 0.3 + 0.165 + 0.325

Beta after the new allocation = 0.79

New Required rate = Risk free rate + Beta* Market risk premium

New Required rate = 4%+ 0.79*5.5%

New Required rate = 4% +  4.345%

New Required rate = 8.345%

Hence, the change in required rate = 8.829% - 8.345% = 0.4840% . In this case, the project is overvalued if Brandon expects 6.85% . If Higher beta is chosen the portfolio risk would increase and required return from the portfolio would increase.