Question

Calculate the required rate of return for Mudd Enterprises assuming that investors expect a 3.34 rate of inillation in the future. The real risk-free rate is 2.0%, and the market risk premium is 7.5%. Mudd has a beta of 2.0 , and its realioed rate of return has averaged 10.5% over the past 5 years. Round yoor answer to two decimal places.

Answer 1

The required rate of return for Mudd Enterprises can be calculated using the CAPM formula and is found to be 20.34% when factoring in the given parameters of inflation rate, real risk-free rate, market risk premium, and the beta for Mudd.

Step-by-step explanation:

To calculate the required rate of return for Mudd Enterprises, we use the Capital Asset Pricing Model (CAPM). The formula for CAPM is given by: expected rate of return = risk-free rate + beta * (market risk premium).

Given that the expected rate of inflation is 3.34%, the real risk-free rate is 2.0%, the market risk premium is 7.5%, and Mudd's beta is 2.0, we first adjust the risk-free rate to reflect the expected inflation:

Nominal risk-free rate = Real risk-free rate + Expected inflation rate
Nominal risk-free rate = 2.0% + 3.34% = 5.34%

Now we apply the CAPM formula:

Expected rate of return = Nominal risk-free rate + Beta * Market risk premium
Expected rate of return = 5.34% + 2.0 * 7.5% = 5.34% + 15% = 20.34%

Therefore, the required rate of return for Mudd Enterprises is 20.34%, rounded to two decimal places.