Question

Bradley Hotels has a beta of 1.7, while Douglas Farms has a beta of 0.7. The required return on an index fund that holds the entire stock market is 12%. The risk-free rate is 7%. By how much does Bradley's required return exceed Douglas' required return?

Answer 1

Required rate of return for Bradley Hotels

Required rate of return = Risk-free rate + Beta(Amrket rate of return - Risk-free rate)

Required rate of return = 7.00% + 1.70(12.00% - 7.00%)

Required rate of return = 7.00% + (1.70 x 5.00%)

Required rate of return = 7.00% + 8.50%

Required rate of return = 15.50%

Required rate of return for Douglas Farms

Required rate of return = Risk-free rate + Beta(Amrket rate of return - Risk-free rate)

Required rate of return = 7.00% + 0.70(12.00% - 7.00%)

Required rate of return = 7.00% + (0.70 x 5.00%)

Required rate of return = 7.00% + 3.50%

Required rate of return = 10.50%

Therefore, the Bradley's required return exceed Douglas' required return by 5.00% (15.50% - 10.50%)

Hence, the required return will be exceeded by 5.00%