Chapter 10, Problem 1PS

Summary Introduction

To calculate: The estimated rate of return of the investment.

Introduction: The expected rate of return is the value which is expected by the investor after the completion of the maturity period of the investment. This gives the security to the investor for his assumptions.

Answer to Problem 1PS

The expected rate of return is 15.5% of the stock.

Explanation of Solution

Here, the expected rate of return is calculated as given below,

Return rate = $[E\left(R\right)+{\beta }_1{F}_1+{\beta }_2{F}_2]$ , here first we calculated $F_1$ and $F_2$ .

Now calculate $F_1$ , A the value of actual (IP) is 5% and E (IP) is 3%

  $\begin{array}{l}{F}_1 =5\%-3\% \\ =2\%\end{array}$

Now calculate factor $F_2$ , $F_2=\left[Actual\left(IR\right)–E\left(IR\right)\right],$

  $\begin{array}{l}{F}_2=8\%-5\% \\ =3\%,\end{array}$

Now substitute the values of factor in equation, we get,

  $\begin{array}{l}\text{Return rate}\left(R\right)=\left[E\left(R\right)+{\beta }_1{F}_1+{\beta }_2{F}_2\right]\\ =12\%+1\times 2\%+0.5\times 3\%\\ =15.5\%\end{array}$

Hence the expected rate of return is 15.5 % for the firm.