Question

Porter Plumbing's stock had a required return of 13.50% last year, when the risk-free rate was 5.50% and the market risk premium was 4.75%. Then an increase in investor risk aversion caused the market risk premium to rise by 2%. The risk-free rate and the firm's beta remain unchanged. What is the company's new required rate of return? (Hint: First calculate the beta, then find the required return.)

Answer 1

The new required rate of return is computed as shown below:

The beta of the firm is computed as shown below:

required return last year = risk free rate + beta x market risk premium

0.1350 = 0.0550 + beta x 0.0475

0.08 = 0.0475 x beta

beta = 1.684210526

So, the new required rate of return will be as follows:

= risk free rate + beta x market risk premium

= 0.0550 + 1.684210526 x ( 0.0475 + 0.02)

= 0.0550 + 1.684210526 x 0.0675

= 16.87% Approximately

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