Question

HR Industries (HRI) has a beta of 1.9; 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 r_RF 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

Given,

HR beta = 1.9

LR beta = 0.4

Decrease in risk free rate = 1.5%

New market return = 10.5%

Solution :-

New risk free rate = 6% - 1.5% = 4.5%

HR required return = new risk free rate + HR beta x (new market return - new risk free rate)

= 4.5% + 1.9 x (10.5% - 4.5%)

= 4.5% + 1.9 x 6%

= 4.5% + 11.4% = 15.90%

LR required return = new risk free rate + LR beta x (new market return - new risk free rate)

= 4.5% + 0.4 x (10.5% - 4.5%)

= 4.5% + 0.4 x 6%

= 4.5% + 2.4% = 6.90%

Difference in the required returns for HRI and LRI

= 15.90% - 6.90%

= 9.00%

answered by: anonymous