The CFO of Ramekin Pottery Inc. is concerned about holding up the price of the company’s stock. He’s asked you to do an analysis starting with an estimate of the return investors are likely to require before they will invest in the firm. The overall stock market is currently returning 16%, 90-day treasury bills yield 6%, and the return on Ramekin’s stock typically responds to changes in the political and economic environment only about 60% as vigorously as does that of the average stock.
a. Prepare an estimate of the firm’s required return using the CAPM.
b. Is a higher or lower required return good for the company? Why?
c. Suppose the CFO asks you what management can do to improve the required return? How will you respond?
d. What will you tell him if he wants it done within the next three months?