Question

A stock has an expected return of 13 percent, its beta is 1.80, and the expected return on the market is 9.5 percent. What must the risk-free rate be? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Answer 1

The answer is 5.13percent

Step-by-step explanation:

The formula to be used here is from Capital Asset Pricing Model (CAPM) and it is used to determine the cost of equity or the expected return on a company's equity.

The formula is

Ke = Rf + beta(Rm - Rf)

Where Ke is Cost of equity(13 percent)

Rf is the risk free rate of return

Rm is the market risk(9.5 percent)

beta = 1.80

To solve for Rf;

0.13 = Rf + 1.8(0.095 - Rf)

0.13 = Rf + 0.171 - 1.8Rf

0.13 - 0.171 = Rf - 1.8Rf

-0.041 = -0.8Rf

Rf = 0.041 ÷ 0.8

=0.0513

5.13percent