Assume you are asked to evaluate two more stocks T and C Sto

Assume you are asked to evaluate two more stocks, T and C. Stock T has a beta of 0.85 and is currently selling for $45. It is expected to pay a dividend of $1.25 and sell at the end of the year for $50. Stock. Stock C has a beta of 1.35 and is expected to pay no dividends. It is currently trading at $67 and will sell at the end of the year for $82. Which stock will you recommend?

Solution

expected return on T = (1.25+50)/45 - 1 = 13.89%

expected return on C = 82/67 - 1 = 22.39%

Stock C has a higher risk and higher expected return than T

To determine whether the expected return is more than the required return, Risk free rate and market risk premium is required since:

Required return = risk free rate + beta* market risk premium