Equity Investments Q178
178A mutual fund manager is looking to invest in a company’s stock with the
following characteristics:
following characteristics:
| Risk-free rate | 2.50% |
| Market risk premium | 4.30% |
| Stock’s beta | 1.9 |
| Manager’s expected rate of return | 9.55% |
| Company’s weighted average cost of capital | 9.25% |
Based on this information, which of the following would be most appropriate investment decision for the fund manager?
- Option : B
- Explanation : Stock’s required return according to CAPM = risk free rate + beta * market risk premium = 0.025 + 1.9 * 0.043 = 10.67%. Since the stock’s required return (10.67%) is greater than the expected rate of return (9.55%), the correct decision is to not invest.
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