Your broker has advised you that he believes that the stock of Brat Inc. is going to rise from $20 to $22.15 per share over the next year. You know that the annual return on the S&P/TSX composite index has been 11.25% and the 90-day T-bill rate has been yielding 4.75% per year over the past 10 years. If beta for Brat is 1.25, will you purchase the stock?
A) Yes, because it is overvalued
B) No, because it is overvalued
C) No, because it is undervalued
D) Yes, because it is undervalued
E) Yes, because the expected return equals the estimated return

Question

Quizplus · Accepted Answer

Expected Return = 4.75 + (1.25)(11.25 - 4.75) = 12.875%
Estimated Return = (22.15 - 20) ¸ 20 = 10.75%
Estimated Return < Expected Return
\ Stock is overvalued and should be sold.

Your Broker Has Advised You That He Believes That the Stock