Frank & Sons, a 100% equity financed firm, has a beta equal to 1.3.  The firm’s stock is currently trading at $25 per share, and pays a $1.50 per share dividend.  Treasury securities are trading at prices that result in a 7% yield, while current projections claim a 15% return from the stock market.  If Frank & Sons has identified an investment that has a beta of 0.96, what rate of return should it require on the project

Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
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Frank & Sons, a 100% equity financed firm, has a beta equal to 1.3.  The firm’s stock is currently trading at $25 per share, and pays a $1.50 per share dividend.  Treasury securities are trading at prices that result in a 7% yield, while current projections claim a 15% return from the stock market.  If Frank & Sons has identified an investment that has a beta of 0.96, what rate of return should it require on the project

Expert Solution
Step 1

As per CAPM,

Required Rate of return = Risk free Rate + Beta * (Market return - Risk free Rate)

Risk free Rate = 7%

Beta =0.96

Market Return = 15%

 

Step 2

Required Rate of return =7%  + (0.96) * (15%-7%)

Required Rate of return =7%  + (0.96) * 8%

Required Rate of return =7%  + 7.68%

Required Rate of return =14.68%

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