Question

HR Industries (HRI) has a beta of 2.2, while LR Industries's (LRI) beta is 0.4. The risk-free rate is 6%, and the required rate of return on an average stock is 13%. The expected rate of inflation built into rRF falls by 1.5 percentage points; the real risk-free rate remains constant; the required return on the market falls to 10.5%; and all betas remain constant. After all of these changes, what will be the difference in the required returns for HRI and LRI? Do not round intermediate calculations. Round your answer to two decimal places.

Answer 1

Beta of HR – 2.2; Beta of LR – 0.4 and there are no changes

Risk-Free Rate – 6% but falls by 1.5 to 4.5%

Required Rate of Return – 13% and falls to 10.5%

Required Return on Stock = Risk-Free Return + (Market Risk Premium)(Stock’s Beta)

HR Industries:

Required Return on Stock = 4.5% + (10.5% - 4.5%) (2.2) = 17.7%

LR Industries:

Required Return on Stock = 4.5% + (10.5% - 4.5%) (0.4) = 6.9%

The difference in the required returns for HRI and LRI is = 17.7% - 6.9% = 10.80%