10.5 A few years ago, the Value Line Investment Survey reported the following ma
ID: 2639539 • Letter: 1
Question
10.5 A few years ago, the Value Line Investment Survey reported the following market betas for the stock selected healthcare providers:
Company Beta
Quorum Health Group 0.90
Beverly Enterprises 1.20
HEALTHSOUTH corp 1.45
United Healthcare 1.70
At the times these Betas were developed, resonable estimates for the risk-frfee rate, RF, and required rate of return on the market, R(Rm), were 6.5 percent and 13.5 percent, respectively.
a. What are the required rates of return on the four stocks?
b.Why do their required rates of return differ?
c. Suppose that a person is planning to invest in olny one stock rather than a well-diversified stock portfolio. Are the required rates of return calculated above applicable to the investment> Explain your answer.
Explanation / Answer
Required rate of return on the Four Stocks
Quorum Health Group - Beta 0.90
Risk free rate and required rate of return in the market respectively =6.5% and 13.5%
To calculate the required rate of return on Quorum Health Group
substract risk free rate from market rate , 13.5-6.5 =7%
Multiply risk free rate by stock's beta to calculate market risk premium =6.5% x 0.90 =0.0585 or 5.8%
Adding the market risk premium to risk free rate is the reuired rate of return on equity
=6.5%+5.8% =12.3%
Beverly Enterprises - beta=1.20
Risk free rate and required rate of return in the market respectively =6.5% and 13.5%
To calculate the required rate of return on Beverly Enterprises
substract risk free rate from market rate , 13.5-6.5 =7%
Multiply risk free rate by stock's beta to calculate market risk premium =6.5% x1.20 =7.8%
Adding the market risk premium to risk free rate is the reuired rate of return on equity
the reuired rate of return on Beverly Enterprises =7.8%+6.5% =14.3%
HEALTHSOUTH corp - Beta =1.45
Risk free rate and required rate of return in the market respectively =6.5% and 13.5%
To calculate the required rate of return on HEALTHSOUTH corp
substract risk free rate from market rate , 13.5-6.5 =7%
Multiply risk free rate by stock's beta to calculate market risk premium =6.5% x1.45 =0.094 or 9.4%
Adding the market risk premium to risk free rate is the reuired rate of return on equity
the reuired rate of return on HEALTHSOUTH corp =9.4%+6.5% = 15.9%
United Healthcare - Beta =1.70
Risk free rate and required rate of return in the market respectively =6.5% and 13.5%
To calculate the required rate of return on United Healthcare
substract risk free rate from market rate , 13.5-6.5 =7% - market premium
Multiply risk free rate by stock's beta to calculate market risk premium =6.5% x1.70 =11.05
Adding the market risk premium to risk free rate is the reuired rate of return on equity
=the reuired rate of return on United Healthcare is 11.05%+6.5% =17.55%
b) Their required rate of rreturns differ because their beta differs.
c) Yes, the required rate of return calculated above is applicable to the investment and a rationale investor will be willing to invest his money in a stock whose rate of return exceeds the market rate of retun . in our case , the investor will be willing to invest in
either
United Healthcare
or
HEALTHSOUTH corp whose return is greater than the market return.
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.