Question

. What is the required return on an investment with a beta of 1.3 if the risk-free rate is 2.0 percent and the return on the market is 8.1 percent? If the expected return on the investment is 11.2 percent, what should you do?

Answer 1

ToTcalculate required return on investment we will use CAPM method. As per CAPM method,

ROE = Rf + b(Rm - Rf)

Where Rf = risk free rate

b = beta

Rm = return on market

So, required return on investment = 2.0% + 1.3(8.1% - 2.0%)

= 2.0% + 7.93%

= 9.93%

Since ROE means required return on investment which is 9.93% only. It means that we required 9.93% only if we invest in this particular project whereas expected return means the return which is expected to be given by the project which is 11.2%. since we need only 9.93% and the project is giving 11.2% and hence the project is giving more then what we require and so we should accept the project.