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The expected return on the market portfolio is 15%. The risk-free rate is 8%. The expected...

The expected return on the market portfolio is 15%. The risk-free rate is 8%. The expected return on SDA Corp. common stock is 16%. The β of SDA Corp. common stock is 1.25. Within the context of the Capital Asset Pricing Model, is the common stock of SDA Corp. overpriced, underpriced or fairly priced?

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Answer #1

Risk-free Rate = 8.00%
Market Return = 15.00%
Beta = 1.25

Required Return = Risk-free Rate + Beta * (Market Return - Risk-free Rate)
Required Return = 8.00% + 1.25 * (15.00% - 8.00%)
Required Return = 8.00% + 1.25 * 7.00%
Required Return = 16.75%

Expected Return (16%) is less than required return (16.75%), therefore, the stock is overpriced.

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