Firm X and Y each have a beta of 1.5 and 2.5. If their expected return...

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Question

Firm X and Y each have a beta of 1.5 and 2.5. If their expected return (cost of equity) are each estimated to be 7% and 10% u

Answer 1

Answer #1

Expected return=risk free rate+beta*(market rate-risk free rate)

7=Rf+1.5*(Rm-Rf)

7=1.5Rm-0.5Rf

Rm=(7+0.5Rf)/1.5

Also:

10=Rf+2.5*(Rm-Rf)

10=2.5*Rm-1.5Rf

10=2.5*(7+0.5Rf)/1.5-1.5Rf

10=11.667+0.833Rf-1.5Rf

Rf=(11.667-10)/(1.5-0.833)

=2.5%=risk free rate

Rm=(7+0.5Rf)/1.5

=5.5%=market rate

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Answer 2

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