Question

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 6%. A stock with a beta of 1.0 on IP and .4 on IR currently is expected to provide a rate of return of 14%. If industrial production actually grows by 5%, while the inflation rate turns out to be 7%, what is your best guess for the rate of return on the stock?

Answer 1

Answer:

The new rate of return is 15.4%

Explanation:

The reviewed estimate on the rate of return on the stock will be:  

• Beforehand  

• 14% = α + [4%*1] + [6%*.4]  

α = 7.6%  

• With the changes:  

• 7.6% + [5%*1] + [7%*.4]  

Now a new rate of return is 15.4%