Question

IR Industries (HR) has a beta of 1.4: UR Industries's (LRI) beta is 0.6. The risk-free rate is 6%, and the required rate of return on an average stock is 13. The speed rate of inflation isk-free rate remains constant, the required return on the market falls to 10.5%, and all butas remain constant. After all of these changes, what will be the difference in the required returns for a calculations. Round your answer to two decimal places.

Answer 1

Solution :- According to Capital asset pricing model (CAPM),

Required return of stock = Risk free rate + Beta of stock * (Market rate of return - Risk free rate).

Required return of stock in IR industries (HR) = 6 % + 1.4 * (10.5 % - 6 %)

= 6 % + 1.4 * 4.50 %

= 6 % + 6.30 %

= 12.30 %

Required return of stock in UR industries (LRI) = 6 % + 0.60 * (10.5 % - 6 %)

= 6 % + 0.60 * 4.50 %

= 6 % + 2.70 %

= 8.70 %

Difference in required return = Required return of stock in IR industries (HR) - Required return of stock in UR industries (LRI)

= 12.30 % - 8.70 %

= 3.60 %

Conclusion :- Difference in required return = 3.60 % (approx).

(Note :- There will not be any application in solution part of the required rate of return on average stock measuring 13 % as given in the question).