5 Several years ago, the Value Line Investment Survey reported the following mar

Question

5 Several years ago, the Value Line Investment Survey reported the following market betas for the stocks of selected healthcare providers: Company Beta Quorum Health Group .90 Beverly Enterprises 1.20 HEALTHSOUTH Corporation 1.45 United Healthcare 1.70 At the time these betas were developed, reasonable estimates for the risk-free rate, FR, and required rate of return on the market, R 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 only on 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

I like to break down and look at all the given: Company-------------------------------Beta Beta Quorum Health Group---------0.9 Beverly Enterprises------------------1.2 HEALTHSOUTH Corp------------------1.45 United Healthcare--------------------1.7 R_f = 1.2% (6/5=1.2) R_m = 13.5% a) Required Rate of Return, we can simply use CAPM: Return = R_f + Beta (R_m-R_f) Beta Quorum = 1.2% + 0.9*(13.5%-1.2%) = 12.27% Beverly = 1.2% + 1.2 *(13.5%-1.2%) = 15.96% HEALTHSOUTH Corp = 1.2% + 1.45*(13.5%-1.2%) = 19.035% United Healthcare = 1.2% + 1.7*(13.5-1.2%) = 22.11% b) They have different rate of return because they have different betas, which is a measure of their risks. The difference in betas could be due to many different factors such as amount of the debt they carry or their operating efficiency c) Yes, the above rates does apply to the investment. Because the above rate of return are representing how much stockholders should get through their investment.

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