Bama Entertainment has common stock with a beta of 1.22. The market risk premium is 8.1 percent and the risk-free rate is 3.9 percent. What is the expected return on this stock?

The answer is =13.8%

Explanation:

The expected rate of return is the rate the shareholders are expecting on their invested funds.

We have many methods to arrive at expected rate of return but in this question, we will make use of what we called Capital Asset Pricing Model(CAPM) and the formula is:

Risk free rate + beta(Market rate - risk free rate)

Please note that (market rate - risk free rate) is also market premium

Therefore, the new formula is:

Risk free rate + beta(market premium)

3.9 + 1.22(8.1)

3.9 + 9.882

=13.8%

Expected return is 13.78%

Explanation:

Capital asset pricing model measure the expected return on an asset or investment. it is used to make decision for addition of specific investment in a well diversified portfolio.

Formula for CAPM

Expected rate of return = Risk free rate + beta ( market premium )

Expected rate of return = Rf + β ( Mp )

Rf = 3.9%

β = 1.22

Mp = 8.1%

Expected rate of return = 3.9% + 1.22 ( 8.1% )

Expected rate of return = 13.78%

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