Suppose two factors are identified for the U. S. economy: the growth rate of industrial production, IP, and the inflation rate, IR. IP is expected to be 4% and IR 5%. A stock with a beta of 1 on IP and 0.6 on IR currently is expected to provide a rate of return of 16%. If industrial production actually grows by 5%, while the inflation rate turns out to be 6%, what is your best guess for the rate of return on the stock? (Round your answer to 1 decimal place.)

Question

Jerry Ritter

Business

31 December, 09:40

Suppose two factors are identified for the U. S. economy: the growth rate of industrial production, IP, and the inflation rate, IR. IP is expected to be 4% and IR 5%. A stock with a beta of 1 on IP and 0.6 on IR currently is expected to provide a rate of return of 16%. If industrial production actually grows by 5%, while the inflation rate turns out to be 6%, what is your best guess for the rate of return on the stock? (Round your answer to 1 decimal place.)

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Answers (1)

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Roxy · Answer 1

17.6%

Explanation:

According to the scenario, computation of the given data are as follow:-

We can calculate the rate of return on the stock by using following formula:-

Expected Provide Rate of Return = Estimate Rate of Return on the Stock + (Expected IP * Stock with a Beta on IP) + (Expected IR * Stock with a Beta on IR)

Before estimate rate of return on the stock

= 16% = α + (4% * 1) + (5% * 0.6)

= 16% = α + (0.04 * 1) + (0.05 * 0.6)

= 0.16 = α + 0.04 + 0.03

= 0.16 - 0.04 - 0.03 = α

α = 0.09 = 9%

Rate of return after the changes

= 9% + (5% * 1) + (6% * 0.6)

= 0.09 + 0.05 + 0.036

= 0.176

= 17.6%

According to the analysis, New rate of return on the stock is 17.6%