Question

Greshak Company's stock has a beta coefficient of 1.4 and a required rate of return of...

Greshak Company's stock has a beta coefficient of 1.4 and a required rate of return of 14%. The equity risk premium is currently 5%. If the inflation premium increases by 1.0%, and Greshak acquires new assets which increase its beta by 50%, what will be the company’s new required equity rate of return?

Select one:

a. 18.50%

b. 13.50%

c. 22.80%

d. 15.25%

e. 17.00%

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Answer #1

Correct answer: a. 18.50%

Current Required return = 14%

Current Beta = 1.4

Equity risk premium (market risk premium) = 5%

Current risk free rate = 0.14-1.4*0.05 = 0.07 = 7%

New Beta = 1.4*(1+50%) = 2.1

Inflation premium increases by = 1%

New risk free rate = 0.07+0.01 = 8%

Thus, New required rate of return :

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