Suppose that two factors have been identified for the U. S. economy: the growth rate of industrial production, IP, and the inflation rate, IR. IP is expected to be 3%, and IR 5%. A stock with a beta of 1 on IP and .5 on IR currently is expected to provide a rate of return of 12%. If industrial production actually grows by 5%, while the inflation rate turns out to be 8%, what is your revised estimate of the expected rate of return on the stock

Revised estimated expected rate of return is 15.5%

Revised estimated expected rate of return = Rate of return + beta[IR - IP] + Beta IP[Inflation rate - growth rate]

Revised estimated expected rate of return = 12% + 1[5% - 3%] + 0.5[8% - 5%]

Revised estimated expected rate of return = 12% + 1[2%] + 0.5[3%]

Revised estimated expected rate of return = 12% + 2% + 1.5%

Revised estimated expected rate of return = 15.5%

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The correct answer is 15.5%.

Explanation:

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

IP = 3%

IR = 5%

Stock with beta on IP = 1

Stock with beta on IR = 0.5

RR = 12%

So,

12% = a + ( 3% × 1 ) + ( 5% × 0.5)

12% = a + 3% + 2.5%

a= 12% - 5.5% = 6.5%

So, revised expected rate of return can be calculated as follows:

RR = 6.5% + ( 5% × 1) + ( 8% × 0.5)

RR= 6.5% + 5% + 4%

RR = 15.5%

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