Investors expect the market rate of return in the coming year to be 12%. The T-bill rate is 4%. Changing Fortunes Industries’ stock has a beta of .5. The market value of its outstanding equity is $100 million.
a. What is your best guess currently as to the expected rate of return on Changing Fortunes’ stock? You believe that the stock is fairly priced.
b. If the market return in the coming year actually turns out to be 10%, what is your best guess as to the rate of return that will be earned on Changing Fortunes’ stock?
c. Suppose now that Changing Fortunes wins a major lawsuit during the year. The settlement is $5 million. Changing Fortunes’ stock return during the year turns out to be 10%. What is your best guess as to the settlement the market previously expected Changing Fortunes to receive from the lawsuit. (Continue to assume that the market return in the year turned out to be 10 %.) The magnitude of the settlement is the only unexpected firm-specific event during the year.