a manager believes his firm will earn a 14.00 percent return next year. his firm

Question

a manager believes his firm will earn a 14.00 percent return next year. his firm has a beta of 1.36, the expected return on the market is 12.00 percent and the risk-free rate is 6.00 percent a manager believes his firm will earn a 14.00 percent return next year. his firm has a beta of 1.36, the expected return on the market is 12.00 percent and the risk-free rate is 6.00 percent a manager believes his firm will earn a 14.00 percent return next year. his firm has a beta of 1.36, the expected return on the market is 12.00 percent and the risk-free rate is 6.00 percent

Explanation / Answer

Let us calculate required return as per CAPM method

As per CAPM = Rj=Rf+b(Rm-Rf)

Rf= risk free return

Rm = Risk premium

b = beta

Rj=6%+1.36(12%-6%)

=6%+1.36(6%)

=6%+8.16%

=14.16%

If firm will earn 14% next year than it will below the expectation of shareholders and thus there would be sell off in the market. Thus share is overvalued.

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