Question

You are given the following information for Wine and Cork Enterprises (WCE):

r_RF = 4%; r_M = 8%; RP_M = 4%, and beta = 1

What is WCE's required rate of return? Do not round intermediate calculations. Round your answer to two decimal places.

%

If inflation increases by 1% but there is no change in investors' risk aversion, what is WCE's required rate of return now? Do not round intermediate calculations. Round your answer to two decimal places.

%

Assume now that there is no change in inflation, but risk aversion increases by 1%. What is WCE's required rate of return now? Do not round intermediate calculations. Round your answer to two decimal places.

%

If inflation increases by 1% and risk aversion increases by 1%, what is WCE's required rate of return now? Do not round intermediate calculations. Round your answer to two decimal places.

Answer 1

a.

r_RF = Risk Free Rate= 4%;

r_M = Market Return = 8%;

RP_M = Market Risk Premium = 4%,

Beta = 1

WCE's required rate of return (under Capital Asset Pricing Model) = r_RF + (Beta * (RP_M))

= 4%+(1*4%) = 4%+4% = 8.00%

WCE's required rate of return = 8.00%

b. Inflation increases by 1%

If Inflation increases by 1%, then the Risk Free Rate will increase by 1% to 5% (4%+1%)

WCE's required rate of return (under Capital Asset Pricing Model) = r_RF + (Beta * (RP_M))

= 5%+(1*4%) = 5%+4% = 9.00%

WCE's required rate of return = 9.00%

c. Risk Aversion increases by 1%

If risk aversion increases by 1%, then the market risk premum will increase by 1% to 5% (4%+1%)

WCE's required rate of return (under Capital Asset Pricing Model) = r_RF + (Beta * (RP_M))

= 4%+(1*5%) = 4%+5% = 9.00%

WCE's required rate of return = 9.00%

d. Risk Aversion increases by 1% and Inflation increases by 1%

If risk aversion increases by 1%, then the market risk premum will increase by 1% to 5% (4%+1%)

If Inflation increases by 1%, then the Risk Free Rate will increase by 1% to 5% (4%+1%)

WCE's required rate of return (under Capital Asset Pricing Model) = r_RF + (Beta * (RP_M))

= 5%+(1*5%) = 5%+5% = 10.00%

WCE's required rate of return = 10.00%