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Bank of America’s common stock (NYSE: BAC) is now trading at $20 per share and has...

Bank of America’s common stock (NYSE: BAC) is now trading at $20 per share and has a beta of 1.5. The risk-free rate is 2% per year and the market return is expected to stay at 12% per year. An analyst forecasts that BAC currently has an expected annual return of 18%. If the analyst is right, is BAC undervalued? Should you buy the stock?

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Answer #1

Required return as per CAPM = risk free rate + (Market return -risk free rate)*beta

= 2%+(12%-2%)*1.5

= 17%

The expected return as per the analyst = 18%

Since the Return using CAPM is lower than the expected return , stock is undervalued.

Hence the analyst is correct.

Since the stock is Undervalued, the stock should be bought.

Answer = Under Valued

Yes.

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