As an equity analyst you are concerned with what will happen to the required return to Universal Toddler Industries’ stock as market conditions change. Suppose rFR=5%, rM=12%, and bUTI=1.4.
a) Under current conditions, what is the rUTI, the required rate of return on UTI stock?
b) Now suppose rFR (1) increase to 6% or (2) decreases to 4%. The slope of the SML remains constant. How would this affect rM and rUTI?
c) Now assume rFR remains at 5% but rM (1) increases to 14% or (2) falls to 11%. The slope of the SML does not remain constant. How would these changes affect rUTI?