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1) If the expected return on the market portfolio (i
1) If the expected return on the market portfolio (i.e., Rm) is 15%, if the risk-free rate (i.e., Rf) is 4% and if the beta of Homton, Inc. stock is 1.57, what is the equilibrium expected rate of return on Homton's stock according to the Capital Asset Pricing Model?
2) Calculate the discount rate consistent with a cap rate of 12 percent and a growth rate of 6 percent. Show how your answer would change if the cap rate dropped to 10 percent while the growth rate declined to 5 percent.
Expert Solution
1) Computation of the equilibrium expected rate of return on Homton's stock:-
Expected rate of return = Risk free rate + Beta * (Expected market return - Risk free rate)
= 4% + 1.57 * (15% - 4%)
= 4% + (1.57 * 11%)
= 4% + 17.27%
= 21.27%
2) Computation of the discount rate:-
Discount rate = Cap rate + Growth rate
= 12% + 6%
= 18%
Computation of the change in discount rate:-
Change in discount rate = Change in cap rate + Change in growth rate
= 10% + 5%
= 15%
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