Question

Beale Manufacturing Company has a beta of 1.2, and Foley Industries has a beta of 0.4. The required return on an index fund that holds the entire stock market is 8.5%. The risk-free rate of interest is 6%. By how much does Beale's required return exceed Foley's required return? Round your answer to two decimal places

Answer 1

CAPM mode:

Required return = Risk free return + Beta x (Market return - Risk free return)

Risk free rate = 6%

Market return = 8.5%

----- Applying CAPM to each --------

A. Required return for Beale Manufacturing Company with beta of 1.2:

Required return = 6% + 1.2 x (8.5%-6%)

= 6% + 1.2 x 2.5%

= 6% + 3%

= 9.00%

B. Required return for Foley Industries with beta of 0.4:

Required return = 6% + 0.4 x (8.5%-6%)

= 6% + 0.4 x 2.5%

= 6% + 1%

= 7.00%

Now,

Difference in Required rate of return = 9.00% - 7.00%

Hence,

Beale’s required rate of return exceed Foley’s by 2.00%