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    Estimate expected returns, find the beta and return on fund

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    Estimate expected returns and find the beta and the return on the fund.

    1. You use a factor model to estimate expected returns on Daemon stock. The risk-free rate is 3%. You have the following information:
    Factor Factor Beta Risk Premium
    GNP .80 .49%
    Inflation 1.20 -.83%
    Market .45 6.36%

    2. Honest Dave's Used Mutual Fund has a $200 million portfolio invested in the following stocks:
    Stock Investment Beta
    Fraud Motors 60M 0.5
    BIM 50M 2.0
    Motel Electronics 30M 4.0
    Major Foods 40M 1.0
    William Television Company 20M 3.0

    a) The expected risk-free rate is 4% and the expected return on the market is 16%. Find the beta and the return on the fund.

    b) Suppose management receives a proposal to purchase a new stock. The investment needed to take a position in the stock is 50 million; it will have an expected return of 18% and its estimated beta coefficient is 2.50. Should the stock be purchased? At what expected return would management be indifferent to purchasing the stock?

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    Solution Preview

    See the attached file.

    Solution 1

    Expected return = Rf + Beta1(Rm - Rf) + Beta2(RGNP - Rf) + Beta3(Rinf - Rf)

    Rf = 0.03
    Beta Risk premium
    0.8 0.0049
    1.2 -0.0083
    0.45 0.0636

    threfore, ...

    Solution Summary

    The solution carefully presents the formulas and calculation to understand the answers to the problem. There is a short paragraph of narrative in response to part b.

    $2.19

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