Question

Beale Manufacturing Company has a beta of 1.1, and Foley Industries has a beta of 0.40. The required return on an index fund that holds the entire stock market is 11%. The risk-free rate of interest is 3.5%. By how much does Beale's required return exceed Foley's required return? Do not round intermediate calculations. Round your answer to two decimal places.

Answer 1

According to CAPM;

required return = risk free rate + beta *(market return - risk free rate)

first let us know the required return of Beale;

=> 3.5% + 1.1*(11%-3.5%)

=>11.75%.

now,

let us know the required retur of Foley;

=>3.5% +0.40*(11%-3.5%)

=>6.5%.

Beale's return exceeds Foley's by;

=>11.75% -6.5%

=>5.25%.

Alternate procedure:

the excess return of Beale can be known by ;

=> (beta of beale - beta of foley)* (market return - risk free rate)

=>(1.1-0.40)*(11%-3.5%)

=.0.70*7.5%

=>5.25%.....(same as above).