Question

Mikkelson Corporation's stock had a required return of 11.75% last year, when the risk-free rate was 5.50% and the market risk premium was 4.75%. Then an increase in investor risk aversion caused the market risk premium to rise by 2%. The risk-free rate and the firm's beta remain unchanged. What is the company's new required rate of return? (Hint: First calculate the beta, then find the required return.)

Answer 1

The new required rate of return is 14.41%

Step-by-step explanation:

The required rate of return (r) is the minimum return that investors require to invest in a company's stock. The required rate of return can be calculated using the CAPM approach. The formula for required rate of return (r) is,

r = rRF + Beta * rpM

Where,

• rRF is the risk free rate
• rpM is the market risk premium

Using the old values, we calculate the beta of stock to be,

0.1175 = 0.055 + Beta * 0.0475

0.1175 - 0.055 = Beta * 0.0475

0.0625 / 0.0475 = Beta

Beta = 1.3158 rounded off to 1.32

The new risk premium = 4.75% + 2% = 6.75%

The new required rate of return (r) is,

r = 0.055 + 1.32 * 0.0675

r = 0.1441 or 14.41%

The rounded off figure for beta is used in calculation of new required rate of return so the answer might differ a little if the figure for beta was not rounded off.