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Rate of Return on a Stock

As an equity analyst you are concerned with what will happen to the required return to Universal Toddler Industries's stock as market conditions change. Suppose rRF = 5%, rM = 12%, and bUTI = 1.4.

(a) Under current conditions, what is rUTI, the required rate of return on UTI stock?
(b) Now suppose rRF (1) increases to 6% or (2) decreases to 4%. The slope of the SML remains constant. How would this affect rM and rUTI?
(c) Now suppose rRF remains at 5% but rM (1) increaes to 14% or (2) falls to 11%. The slope of the SML does not remain constant. How would these changes affect rUTI?

Answer is:

a. ri = 14.8%
b. (1) rM = 13%; ri = 15.8%
(2) rM = 11%; ri = 13.8%
c (1) ri = 17.6%
(2) ri = 13.4%

I need to be able to show I came up with these answers.

Solution Preview

(a)
rUTI = rRF + bUTI*(rM - rRF)
=> rUTI = 5% + 1.4*(12%-5%)
=> rUTI = 14.8%

(b)
If rRF increases to 6%
rM ...

Solution Summary

The solution provides step by step solution to the question being asked. Standard formula is used to determine the answer and steps are shown clearly and concisely.

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