The expected return on the market is 13.8 percent and the risk-free
rate is 6.4 percent. Company A stock has a beta of 1.2

1) What is the expected return on the Company A stock?
2) If the risk free rate decreases to 3.5 percent, what is the
expected return on the Company A stock?

Hi doogieh59!!


1) What is the expected return on the Company A stock?

According to the CAPM:

E = rf + Beta * [rM ? rf]

where
E = the expected return
rf = the risk-free rate = 0.064
rM = the expected return on the market = 0.138

Then:

E = 0.064 + 1.2 * (0.138 - 0.064) = 
  = 0.064 + 1.2 * 0.074 =
  = 0.1528 = 15.28%

The expected return on Company A's stock is 15.28%.

See for references "Capital Asset Pricing Model - CAPM":
http://www.investopedia.com/terms/c/capm.asp

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2) If the risk free rate decreases to 3.5 percent, what is the
expected return on the Company A stock?

E = 0.035 + 1.2 * (0.138 - 0.035) = 
  = 0.035 + 1.2 * 0.103 =
  = 0.1586 = 15.86%

If the risk free rate decreases to 3.5 percent, the expected return on
Company A's stock is 15.86%.

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I hope that this helps you. Feel free to request for a clarification
if you need it.

Regards.
livioflores-ga