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Henessey Markets has a growth rate of 4.8 percent and is equally as risky as the market. The stock is currently selling for $17 a share. The overall stock market has a 10.6 percent rate of return and a risk premium of 8.7 percent. What is the expected rate of return on this stock?

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Answer:             ER(P)  =  Rf + β(Rm-Rf)

                          ER(P) =  1.9 + 1(10.6-1.9)

                          ER(P) = 1.9 + 1(8.7)

                          ER(P) = 10.6%                                                                                                                                                                                          

 

Explanation: In this question, CAPM will be used in determining the expected return of the stock. The risk free rate was not given but it was derived from the difference between overall stock market return and risk-premium ie 10.6%-8.7%, which is equal to 1.9%. In addition, the beta of the stock is 1, which corresponds to market beta.  The application of the stated  figures  in the  CAPM formula gives  an expected return of 10.06%.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    

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