A stock has a beta of 1.32, the expected return on the market is 10 percent, and

Question

A stock has a beta of 1.32, the expected return on the market is 10 percent, and the risk-free rate is 3.5 percent. What must the expected return on this stock be? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

A stock has a beta of 1.32, the expected return on the market is 10 percent, and the risk-free rate is 3.5 percent. What must the expected return on this stock be? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Explanation / Answer

CAPM Model

Risk free rate = 3.5%

Market return = 10%

Beta = 1.32

Expected rate of return is calculated below using CAPM formula:

Expected rate of return = Risk free rate + (Market Return - Risk free rate) × Beta

                                      = 3.5% + (10% - 3.5%) × 1.32

                                      = 3.5% + 6.50% × 1.32

                                      = 3.50% + 8.58%

                                      = 12.08%

Hence, Expected rate of return of company stock is 12.08%.

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