Question

The risk-free return is 4.77 percent, the expected return on the market is 13.25 percent, the expected real return for Litchfield Design stock is 1.04 percent, and the beta for Litchfield Design stock is 1.22. What is the inflation rate expected to be? Answer as a rate in decimal format so that 12.34% would be entered as .1234 and 0.98% would be entered as .0098

Answer 1

The inflation rate is computed as shown below:

= [ (1 + Nominal rate of return) / (1 + real rate of return) ] - 1

Nominal rate of return is computed as follows:

= risk free rate + beta x (return on market - risk free rate)

= 4.77% + 1.22 x (13.25% - 4.77%)

= 15.1156% or 0.151156

So, the inflation rate will be as follows:

= [ (1 + 0.151156) / (1 + 0.0104) ] - 1

= 0.1393 Approximately

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