Bosco, Inc. has a beta coefficient of 1.5 and a required rate of return of 17%. The market risk premium is currently 5%. If inflation premium increases by 3 percentage points and Bosco invests in a new project which increases its beta by 70 percent, what will be the company's new required rate of return according to the CAPM?
| Using CAPM | |||||
| Market Risk Premium = | 5.00% | ||||
| Beta (B)= | 1.50 | ||||
| Required Rate of Return= | 17% | ||||
| Required Rate of Return ( Ke)= | Rf + B x Marker Risk Premium | ||||
| 17%= | Rf + 1.50x 5.00% | ||||
| 17%= | Rf + 7.50% | ||||
| Rf= | 17%-7.5% | ||||
| Rf= | 9.50% | ||||
| If Inflation increase by 3% | |||||
| then | |||||
| New Rf= | 9.5% + 3 %= 12.5% | ||||
| Market Risk Premium = | 5.00% | ( no impact of inflation on risk premium) | |||
| New Beta= | 1.5+ 1.5 x 70%= 1.5+1.05 = 2.55 | ||||
| New required rate of return= | Rf + B x Marker Risk Premium | ||||
| New required rate of return= | 12.5% + 2.55 x 5.00% | ||||
| New required rate of return= | 12.5% + 12.75% | ||||
| New required rate of return= | 25.25% |
Get Answers For Free
Most questions answered within 1 hours.