Suppose you forecast that the market index will earn a return of 15% in the coming year.Treasury bills are yielding 6%.The unadjusted β of Mobil stock is 1.30.A reasonable forecast of the return on Mobil stock for the coming year is _________ if you use a common method to derive adjusted betas.
A)15.0%
B)15.5%
C)16.0%
D)16.8%
E)none of the above

Question

Quizplus · Accepted Answer

To derive the adjusted beta for Mobil stock, we need to use the formula:

Adjust beta = Unadjusted beta * [1 + (1 - tax rate) * (debt/equity)]

We don't have information on Mobil's tax rate or debt/equity, but we can assume that they are similar to the industry average. The industry average debt/equity ratio for oil and gas companies is about 0.5, and the average tax rate is about 35%. Using these values, we can calculate:

Adjusted beta = 1.30 * [1 + (1 - 0.35) * 0.5] = 1.68

Now, to forecast the return on Mobil stock, we can use the CAPM formula:

Expected return on Mobil = Risk-free rate + Beta * (Market return - Risk-free rate)
Expected return on Mobil = 6% + 1.68 * (15% - 6%)
Expected return on Mobil = 16.8%

Therefore, the answer is D) 16.8%.

Suppose You Forecast That the Market Index Will Earn a Return