Question

CCC Corp has a beta of 1.5 and is currently in equilibrium. The required rate of return on the stock is 12.00% versus a required return on an average stock of 10.00%. Now the required return on an average stock increases by 30.0% (not percentage points). Neither betas nor the risk-free rate change. What would CCC's new required return be? Do not round your intermediate calculations.

Answer 1

CCC Corp's new required return would be 17.5% after calculating with the Capital Asset Pricing Model (CAPM), taking into account the increase in the average stock return by 30% and using the previous risk-free rate and beta.

Step-by-step explanation:

The concept of this problem revolves around the Capital Asset Pricing Model (CAPM), which is a finance tool used to calculate the expected return of an investment based on its risk, compared to the overall market. The essential formula for CAPM is:

Expected Return = Risk-Free Rate + (Beta × (Market Return - Risk-Free Rate))

In this case, CCC Corp has a beta of 1.5, and the current required market return is 10.00%. If the market return increases by 30.0%, the new market return becomes 10.00% × 1.30 = 13.00%. The current risk-free rate can be calculated by rearranging the CAPM formula:

Risk-Free Rate = Expected Return - (Beta × (Market Return - Risk-Free Rate))

Substitute the given values:

12.00% = Risk-Free Rate + (1.5 × (10.00% - Risk-Free Rate))
Solving this, we get Risk-Free Rate = 4%.

Using the new market return and the same risk-free rate:

New Expected Return = 4% + (1.5 × (13.00% - 4%))
= 4% + (1.5 × 9%)

= 4% + 13.5%

= 17.5%

So, CCC Corp's new required return would be 17.5%.

Answer 2

CCC's new required return be 16.5%

Step-by-step explanation:

For computing the new required return, first, we have to compute the risk-free rate of return which is shown below:

Expected return = Risk- free rate of return + Beta × (Market risk - Risk- free rate of return)

12% = Risk- free rate of return + 1.5 × (10% - Risk- free rate of return))

12% = Risk- free rate of return + 15% - 1.5% Risk- free rate of return

So, the Risk- free rate of return is 6%

Now the average stock is increased by 30%

So, the new market risk is 13% and other things will remain constant

So, the new required return equal to

= 6% + 1.5 × (13% - 6%)

= 6% + 1.5 × 7

= 16.5%