Question

Calculate the required rate of return for Climax Inc., assuming that (1) investors expect a 4.0% rate of inflation in the future, (2) the real risk-free rate is 3.0%, (3) the market risk premium is 5.0%, (4) the firm has a beta of 2.30, and (5) its realized rate of return has averaged 15.0% over the last 5 years. Do not round your intermediate calculations.

	a.	18.87%
	b.	18.50%
	c.	16.28%
	d.	17.76%
	e.	20.91%

Answer 1

Solution :

The formula for calculating the required rate of return is

= Inflation rate + Risk free rate + ( Beta * Market risk premium )

As per the information given in the question we have

Inflation rate = 4.0 %        ;        Risk free rate = 3.0 %

Beta = 2.30             ;          Market risk premium = 5.0 %

Thus applying the above values in the formula we have

= 4 % + 3 % + ( 2.30 * 5 % )

= 4 % + 3 % + 11.5 %

= 18.5 %

Thus the required rate of the return = 18.5 %

Thus the solution is Option b. 18.5 %