Question

Nagel Equipment has a beta of 0.88 and an expected dividend growth rate of 4.00% per year. The T-bill rate is 4.00%, and the T-bond rate is 5.25%. The annual return on the stock market during the past 4 years was 10.25%. Investors expect the average annual future return on the market to be 14.75%. Using the SML, what is the firm's required rate of return? Do not round your intermediate calculations. (show the work on a scrap paper)

a. 13.61%

b. 11.57%

c. 12.25%

d. 14.70%

e. 12.11%

Answer 1

As per CAPM,

where, rf = Risk free return = 5.25% (Note - we will take the higher T-Bond rate as both are risk free but to calculate the required return we will take the higher one)

Rm = Market Return = 14.75% (Note- Required return is bases on the future expectations thus the Average of Future expected Market return will be Taken)

Beta = 0.88

Required return = 5.25% + 0.88(14.75% - 5.25%)

Required return = 13.61%

Option A

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