question archive 1) A manager believes his firm will earn a 14 percent return next year
1) A manager believes his firm will earn a 14 percent return next year
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1) A manager believes his firm will earn a 14 percent return next year. His firm has a beta of 1.5, the expected return on the market is 12 percent, and the risk-free rate is 4 percent. Compute the return the firm should earn given its level of risk and determine whether the manager is saying the firm is undervalued or overvalued. (Hint: CAPMcapital asset pricing model).
2. At the beginning of the month, you owned $6,000 of News Corp, $5,000 of First Data, and $8,500 of Whirlpool. The monthly returns for News Corp, First Data, and Whirlpool were 8.24 percent, −2.59 percent, and 10.13 percent. What’s your portfolio return?
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Answer:
| Beta, B | 1.5 | |||
| Return on Market, Rm | 12.00% | |||
| Risk Free Rate, Rf | 4.00% | |||
| Ke = Rf+ B(Rm-Rf) | ||||
| Ke = 4% + 1.5(12%-4%) | ||||
| Ke = 4% + 1.5(8%) | ||||
| Ke = 4% + 12% | ||||
| Ke = 16% | ||||
| Since the return required for the level of risk is 16% and the manager believes a 14% return will be achieved, the manager is saying the firm is Overvalued. | ||||
| Portfolio return | 6.29% | |||
| Paticulars | Amount | Weight | Return | Portfolio Return |
| News corp | 6,000.00 | 0.31 | 8.24% | 2.54% |
| First data | 5,000.00 | 0.26 | -2.59% | -0.66% |
| Whirlpool | 8,500.00 | 0.44 | 10.13% | 4.42% |
| 19,500.00 | 1.00 | 6.29% |
