Landon Stevens is evaluating the expected performance of two common stocks, Furh
ID: 2650427 • Letter: L
Question
Landon Stevens is evaluating the expected performance of two common stocks, Furhman Labs, Inc., and Garten Testing, Inc. The risk-free rate is 5.6 percent, the expected return on the market is 13.0 percent, and the betas of the two stocks are 1.8 and .7, respectively. Stevens’s own forecasts of the returns on the two stocks are 17.20 percent for Furhman Labs and 11.60 percent for Garten.
1.
Calculate the required return for each stock. (Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places. Omit the "%" sign in your response.)
Stock Required Return
Furhman Labs %
Garten Testing %
2. Is each stock undervalued, fairly valued, or overvalued?
Furhman Labs
Fair valued
Undervalued
Overvalued
Garten Testing
Overvalued
Fair valued
Undervalued
Explanation / Answer
Answer:1
Furhman Labs:
Required return=Rf+beta (ERm-Rf)
=5.6%+1.8(13%-5.6%)
=18.92%
Garten Testing
required return=Rf+beta (ERm-Rf)
=5.6%+0.7(13%-5.6%)
=10.78%
Answer:2 If the forecast rate of return is less than (greater than) the required rate of return, then the security is overvalued (undervalued).
Fuhrman Labs: Forecast return
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