QUESTION 8

1. Consider Crabby Shores company:

   a) The stock of this company is expected to return 15.7 percent in a booming economy, 9.8 percent in a normal economy, and 2.3 percent in a recession. The probabilities of an economic boom, normal state, or recession are 15 percent, 73 percent, and 12 percent, respectively. What is the expected rate of return on this stock?

   b) Now suppose this stock's beta is 1.4, expected market return of 14% and risk free rate of 4%. What is the required rate of return on this stock?

   c) Given what you found in parts (a) & (b), is this stock in equillibrium? Why? Is it overpriced, fair-priced or under-priced? would you buy it, do nothing, or sell it?