Question

45. An investor expects that a stock purchased for? $60 will be sold for? $70, at which time a dividend of? $1 will be paid. Over this same time? period, the stock has a beta of? 1.2, the market has an expected return of? 16%, and the? risk-free rate is? 6%. What is the best assessment of the? stock's valuation?

a. The stock is fairly valued because the required return equals the expected return.

b. The stock is overvalued because the required return is greater than the expected return.

c. The stock is undervalued because the required return is less than the expected return.

Answer 1

Required Return (r)	Rf+?×Rp
Here,
Risk free rate of return (Rf)	6.00%
Beta of the stock (?)	1.20
Market risk premium (Rp)	10.00%	16%-6%
Required Return (r)	18.00%
	6%+1.2×10%

Expected return:

= ($70+$1-$60) /$60

= 18.33%

Hence, correct option is c. The stock is undervalued because the required return is less than the expected return.