Question

A stock has a required return of 12%; the risk-free rate is 6%; and the market risk premium is 4%.

If the market risk premium increased to 10%, what would happen to the stock's required rate of return?

1. New stock's required rate of return will be  %. Round your answer to two decimal places.

Answer 1

Step-1, Calculation of Beta of the Stock

As per capital asset pricing model (CAPM), the required rate of return is for the company is calculated by using the following formula

Required Rate of Return = Risk-free Rate + [Beta x Market Risk Premium]

Here, we’ve Required Rate of Return = 12.00%

Risk-free rate = 6.00%

Market Risk Premium = 4.00%

Therefore, the Required Rate of Return = Risk-free Rate + [Beta x Market Risk Premium]

12.00% = 6.00% + [Beta x 4.00%]

12.00% - 6.00% = [Beta x 4.00%]

6.00% = [Beta x 4.00%]

Beta = 6.00% / 4.00%

Beta = 1.50

Step-2, Calculation of new stock's required rate of return if the market risk premium increased to 10%

Required Rate of Return = Risk-free Rate + [Beta x Market Risk Premium]

= 6.00% + [1.50 x 10.00%]

= 6.00% + 15.00%

= 21.00%

“Therefore, the new stock's required rate of return will be 21.00%”