Answer:
New required rate of return = 11.88%
Explanation:
The capital asset pricing model is a risk-based model. Here, the return on equity is dependent on the level of reaction of the the equity to changes in the return on a market portfolio. These changes are captured as systematic risk. The magnitude by which a stock is affected by systematic risk is measured by beta.
Under CAPM, Ke= Rf + β(Rm-Rf)
Ke- required rate of return, Rf-risk-free rate (treasury bill rate), β= Beta, Rm= Return on market.
Using the model, we work out Beta which is not given and then re-calculate the required rate of return of the new stock
Ke- 11.75 % Rf- 5.5, Rm-Rf = 4.75%, β= ?
11.75% = 5.50% + β(4.75%)
11.75% -5.50% = β(4.75%)
(11.75-5.50)/4.75= β
1.315789474 = β
1.315 = β
New required rate of return
5.50% + 1.315(1.02×4.75)
11.875
New required rate of return = 11.88%
Answer:
Explanation:
Given
Required rate of return, (Re) = 11.75%
Risk-free rate (Rf) = 5.50%
Market risk premium (Rm - Rf) = 4.75
Let's calculate beta (b) first, by using below formula.
Re = Rf + b (Rm - Rf)
11.75 = 5.50 + b ( 4.75)
By solving, we get beta (b) = 1.3157 = 1.32
Now, market risk premium is increased by 2%.
So, new market risk premium (Rm - Rf) = 6.75%. Beta and Rf values are same.
New Required rate of return (Re) = 5.50 + 1.32 * 6.75
By solving, we get Re = 14.41 %
