(The Following Information Applies to the Next Two Problems

question 12

Multiple Choice

(The following information applies to the next two problems.)
You have been asked to use a CAPM analysis to choose between Stocks R and S, with your choice being the one whose expected rate of return exceeds its required return by the widest margin. The risk-free rate is 6%, and the required return on an average stock (or the "market") is 10%. Your security analyst tells you that Stock S's expected rate of return is equal to 11%, while Stock R's expected rate of return is equal to 12%. The CAPM is assumed to be a valid method for selecting stocks, but the expected return for any given investor (such as you) can differ from the required rate of return for a given stock. The following past rates of return are to be used to calculate the two stocks' beta coefficients, which are then to be used to determine the stocks' required rates of return:
Note: The averages of the historical returns are not needed, and they are generally not equal to the expected future returns.
-Calculate both stocks' betas. What is the difference between the betas? That is, what is the value of betaR - betaS? (Hint: The graphical method of calculating the rise over run, or (Y2 - Y1) divided by (X2 - X1) may aid you.)

• A) 1.3538
• B) 1.4250
• C) 1.5000
• D) 1.5750
• E) 1.6538

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Definitions:

Retail Method

An accounting technique used to estimate inventory value by calculating a cost to retail price ratio and applying it to the ending inventory at retail prices.

Merchandise Inventory

The total value of a retailer's goods that are available for sale to customers.

Estimated Cost

A prediction or forecast of the future cost of a project, operation, or production based on current data and trends.

Gross Profit Rate

A financial metric that measures the difference between sales and the cost of goods sold, expressed as a percentage of sales.