Wilson Farms' stock has a beta of .73 and an expected return of 9.0%. The risk-free rate is 1.9% and the market risk premium is 7.3%. This stock is ________ because the CAPM return for the stock is ________%.
A)undervalued; 7.23
B)undervalued; 7.53
C)undervalued; 7.46
D)overvalued; 7.23
E)overvalued; 7.53

Question

Quizplus · Accepted Answer

Using the CAPM formula, we can calculate that the expected return for Wilson Farms' stock is 1.9% + (0.73 x 7.3%) = 6.38%. Since the expected return based on the CAPM (6.38%) is higher than the given expected return (9.0%), the stock is undervalued. Solving for the required rate of return using the CAPM formula gives us 1.9% + (0.73 x 7.3%) = 6.38%, which rounds to 7.23%. Therefore, the CAPM return for the stock is 7.23%. Choice A is correct.

Wilson Farms' Stock Has a Beta of