Question

The stock of Pizza Hot Inc., a Mexican pizza chain, has an estimated beta of 1.3 . Calculate the required rate of return on Pizza Hot's stock if the SML is estimated as follows: k ⱼ=0.06+0.092βⱼ based on . An initial inflation expectation of 5 percent. Round your answer to one decimal place. % A new inflation expectation of 8 percent. Round your answer to one decimal place. %

Answer 1

The required rate of return on Pizza Hot Inc.'s stock is calculated using the Security Market Line (SML) formula provided. The rate of return is found to be 18.0 percent, and this calculation remains unaffected by the initial or new inflation expectations since they are not included in the SML formula.

Step-by-step explanation:

To calculate the required rate of return on Pizza Hot Inc.'s stock with a beta of 1.3 using the Security Market Line (SML) formula provided, we substitute the beta value into the equation kj = 0.06 + 0.092βj. The initial inflation expectation of 5 percent does not directly affect this calculation, as it is not a part of the SML formula provided.

Using the formula:

• First scenario (initial inflation expectation of 5 percent, which is ignored in SML):
  kj = 0.06 + 0.092(1.3) = 0.06 + 0.1196 = 0.1796, which can be rounded to 18.0 percent.
• Second scenario (new inflation expectation of 8 percent, which is ignored in SML):
  kj = 0.06 + 0.092(1.3) = 0.06 + 0.1196 = 0.1796, which can be rounded to 18.0 percent.

This calculation shows that the required rate of return for Pizza Hot Inc.'s stock remains the same at 18.0 percent regardless of the change in inflation expectation, as per the given SML formula.