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**

Feel free to ask in case of any query relating to this question

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