Question

You are given the following information for Wine and Cork Enterprises (WCE):

r_RF = 3%; r_M = 8%; RP_M = 5%, and beta = 1.2

1. Assume now that there is no change in inflation, but market risk premium increases by 1%. What is WCE's required rate of return now? Do not round intermediate calculations. Round your answer to two decimal places.

2,If inflation increases by 1% and market risk premium increases by 1%, what is WCE's required rate of return now? Do not round intermediate calculations. Round your answer to two decimal places.

Answer 1

r_RF = 3%; r_M = 8%; RP_M = 5%, and beta = 1.2

CAPM

re = rRF + beta * (RPM)

re = 0.03 + 1.2 * 0.05

re = 0.09

re = 9%

1. If RPM = 5% + 1% = 6%

re = rRF + beta * (RPM)

re = 0.03 + 1.2 * 0.06

re = 0.102

re = 10.2%

If the market risk premium increases by 1%, then WCE's required rate of return increases by 1.2 percentage points to 10.2%

2. If inflation increases by 1%, then rRF = 3% + 1% = 4%

re = rRF + beta * (RPM)

re = 0.04 + 1.2 * 0.05

re = 0.1

re = 10%

If the rate of inflation increases by 1%, then WCE's required rate of return increases by 1 percentage points to 10%