Question

1. What is the required rate of return on a stock with a beta of 0.6? Round your answer to one decimal place

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2. Calculate the required rate of return for Mudd Enterprises assuming that investors expect a 4.5% rate of inflation in the future. The real risk-free rate is 1.5%, and the market risk premium is 5.5%. Mudd has a beta of 2.5, and its realized rate of return has averaged 11.5% over the past 5 years. Round your answer to two decimal places.

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Answer 1

Real risk free rate = 1.5%

Inflation = 4.5%

Nominal risk free rate = 1.5% + 4.5% = 6%

Market risk premium = 5.5%

Using CAPM, Required rate of return = Risk free rate + Beta * Market risk premium

1)

Required rate of return = 6% + 0.6* 5.5% = 9.3%

2)

Required rate of return = 6% + 2.5 * 5.5% = 19.75%