4-12

1. Calculate the risk appropriate level of return.
2. Determine whether the stock is undervalued or overvalued.

A manager believes his firm will earn a 16.50 percent return next year. His firm has a beta of .64, the expected return on the market is 14.40 percent, and the risk-free rate is 5.40 percent. Compute the return the firm should earn given its level of risk. Determine whether the manager is saying the firm is undervalued or overvalued. Expected return next year Firm beta Expected return on the market Risk-free rate 16.50% 0.64 14.40% 5.40% Compute the expected return and determine whether the manager is saying the firm is undervalued or overvalued. (Do not round intermediate calculations and round your answers to 2 decimal places.) Risk appropriate level of return Undervalued, overvalued, or fairly valued