You have landed your big job and are making enough money to start investing. You

Question

You have landed your big job and are making enough money to start investing. Your friend has told you about this great stock that she thinks you should buy. After doing all the relevant research you believe that this might be a good investment. Based on all your work, you believe (expect) that the stock will return 10% in dividends and share price appreciation over the next year. You also have the following information:

Stock Price = $50

Company Beta = 1.2

U.S. Treasury Bond Yield = 3%

Net Income = $10,000

Average Return for S&P 500 = 8%

Company Growth Rate = 4%

-Should you buy this stock? Why?

please show work

Explanation / Answer

Required rate of return on company stock according to CAPM model is calculated below:

Requiired rate of return = 3% + (8% - 3%) × 1.20

= 3% + (5% × 1.20)

= 3% + 6%

= 9%

Required rate of return according to CAPM is 9% and expected rate of return on company stock is 10%.

Since, Expected return is higher than required rate of return then the investment is good investment and you should make investment.

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