Question

Suppose the beta of this value based company is 0.85, the risk-free rate is 2 percent, and the expected market rate of return is 10 percent. Calculate the expected rate of return. The answer is closest to:

Group of answer choices

a. 10.5 percent

b. 13.1 percent

c. 6.5 percent

d. 9.0 percent

Answer 1

The expected rate of return, calculated using the Capital Asset Pricing Model given a beta of 0.85, a risk-free rate of 2%, and an expected market rate of return of 10%, is 8.8%. The closest answer choice is 9.0 per cent.

Step-by-step explanation:

The student has been asked to calculate the expected rate of return for a value-based company with a beta of 0.85, a risk-free rate of 2 per cent, and an expected market rate of return of 10 per cent. To calculate this, we use the Capital Asset Pricing Model (CAPM), which is expressed by the formula:

Expected Rate of Return = Risk-Free Rate + Beta x (Market Rate of Return - Risk-Free Rate)

Substituting the given values:

Expected Rate of Return = 2% + 0.85 x (10% - 2%)

Expected Rate of Return = 2% + 0.85 x 8%

Expected Rate of Return = 2% + 6.8%

Expected Rate of Return = 8.8%

The closest answer to 8.8 per cent is option d. 9.0 percent. The expected rate of return is a crucial concept in finance, reflecting the profitability an investor might anticipate from an investment considering its risk level. It illustrates how risk and potential returns are directly related, and it helps in making informed investment decisions.