Question

Home Interior's stock has an expected return of 13.2 percent and a beta of 1.28. The market return is 10.7 percent and the risk-free rate is 2.8 percent. This stock is overvalued or undervalued? ____________ because the CAPM return for the stock is ________ percent. If Home Interior's expected return rose to 14.12%, the stock would be overvalued or undervalued? ____________ because the CAPM return for the stock is ________ percent. Please show your work.

Answer 1

Solution:-

As per Capital Assets Pricing model-

Required Return = Risk Free Rate + Beta * (Market Return - Risk Free Return)

Required Return = 0.028 + 1.28 (0.107 - 0.028)

Required Return = 12.91%

The CAPM Return of the Stock is 12.91%

The Stock ia Undervalued as CAPM Return is lower.

If Exoected Return of stock rose to 14.12% then also stock is undervalued as CAPM return is lower.

If you have any query related to answer so please feel free to ask me in a comment. Thanks.