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Gardner Electric has a beta of 0.88 and an expected dividend growth rate of 4.00% per year. The T-bill rate is 4.00%, and the T-bond rate is 5.25%. The annual return on the stock market during the past 4 years was 10.25%. Investors expect the average annual future return on the market to be 12.50%. Using the SML, what is the firm's required rate of return? Select one:
a. 11.34%
b. 11.63%
c. 11.92%
d. 12.22%
e. 12.52%

Respuesta :

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Answer:

Option B: 11.63%

Explanation:

SML or Security market line is nothing but the Graphical Representation of the Capital Asset Pricing Model (CAPM)      

Which works on the formula as Required Return: Risk free rate of Return + Beta (Market Return - risk free rate of Return)      

Please note that the second part of the above formula i.e. (Market Rate of Return - risk free rate ) is the market premium      

We use SML to get market risk premium      

Required Rate = rf (risk free rate ) + Risk premium    

12.50% = 5.25% + Risk Premium (rPM)  

rPM = 7.25%    

required rate = rf+ Beta * rPM      

= 5.25% + 0.88 * 7.25%    

Firm's required Rate of Return 11.63%  

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