# Estimate expected returns, find the beta and return on fund

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.