Fundamentals of Financial Manageme...
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Fundamentals of Financial Manageme...
CAPM AND REQUIRED RETURN HR Industries (HRI) has a beta of 1.8, while LR Industries’ (LRI) beta is 0.6. The risk-free rate is 6%, and the required rate of return on an average stock is 13%. The expected rate of inflation built into rRF falls by 1.5 percentage points, the real risk-free rate remains constant, the required return on the market falls to 10.5%, and all betas remain constant. After all of these changes, what will be the difference in the required returns for HRI and LRI?
To determine: The difference between the required return.
The required rate of return:
The required rate of return is the minimum rate, which should be earned on an investment to keep that investment running in the market. When the required return is earned, only then the users and the companies invest in that particular investment.
For Company H:
Given,
The value of beta is 1.8.
The required rate of return on an average stock is 13%.
The risk-free rate is 6%.
The expected rate of inflation falls by 1.5 percentage points.
The real risk-free rate remains constant.
The required return on market falls to 10.5%.
The value of beta remains constant.
Calculation of the new risk-free rate:
The new risk-free rate is 4.5%.
Calculation of the required rate of return for stock of Company H:
The formula to calculate the required rate of return is:
Where,
Substitute 4.5% for
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