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    Calculation of Required Rate of Return on a Stock

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    Assume that the risk-free rate is 6% and the expected return on the market is 13%. What is the required rate of return on a stock with a beta of .7?

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    Solution Preview

    Here are the terms and the formula for calculating the expected return:

    Required Rate: Ke
    Risk Free Rate: Rf
    b: Beta Coefficient
    Km: Expected Return

    Ke=Rf + b(Km-Rf)

    Solve as follows:
    Trying to solve for Ke, Rf is given as 6%, b is given as 0.7, Km is given as 13%

    Ke=Rf + b(Km-Rf)
    Ke=6% + 0.7(13%-6%)
    Ke=6% + 0.7(7%)
    Ke=6% + 4.9%

    The required rate is 10.9%

    Here's an explanation of why:

    Basically, we are trying to figure your required rate of return on a stock with relatively low volatility ...

    Solution Summary

    The solution is a calculation of the required rate of return on a stock with given rates including risk free, market, and beta.