Answer:
a; 3%
b; 1%
Explanation:
To answer the question, we proceed as follows;
Firstly, we compute the rate of return:
The rate of return can be calculated using the CAPM model:
According to CAPM,
Rate Of return RE = Rf + β(Rm - Rf)
where, Rf = Risk free rate
Rm = Market return
β = Risk co-efficient
RE = Cost of equity
To find the rate of return, substitute 1% for risk free rate, 1.50% for market return and 2 for beta.
Applying the CAPM model, we get;
Rate of return = 0.01 + 2(0.015 - 0.01)
= 0.02 or simply 2%
Its firm's return due to the lawsuit is $1 million per $100 million initial equity; this means the increase is 1%.
Therefore, the total return should be ;
Total return = 1% + 2% = 3%
If the settlement was expected to be $2 million and the actual settlement has a loss of $1 million, then the firm-specific return would be = 1%
Total return = 2% - 1%
