Suppose the beta of the stock of Microsoft, Inc.is $\beta$_msft=1.45.If r_f=4% and r_M=9%, what is the equilibrium expected return on Microsoft stock, r_msft, according to the CAPM? As an analyst of the firms in the high-technology industry, you expect Microsoft to provide a return of 10% over the next year.Comparing your estimate with equilibrium expected return on Microsoft that you just calculated, would you recommend to your investors that they buy Microsoft stock?

Question

Quizplus · Accepted Answer

Using the Capital Asset Pricing Model (CAPM), the equilibrium expected return on Microsoft stock can be calculated as: r_msft = r_f + β_msft * (r_M - r_f), where r_f is the risk-free rate, β_msft is the beta of Microsoft, and r_M is the market return. Plugging in the given values: r_msft = 4% + 1.45 * (9% - 4%) = 4% + 1.45 * 5% = 4% + 7.25% = 11.25%. Since the analyst's expected return of 10% is lower than the CAPM expected return of 11.25%, it suggests that Microsoft is overpriced according to the CAPM, hence investors should not buy.

Suppose the Beta of the Stock of Microsoft, Inc β\betaβ msft=1

Suppose the Beta of the Stock of Microsoft, Inc $\beta$ _msft=1