Question

CCC Corp has a beta of 1.5 and is currently in equilibrium. The required rate of return on the stock is 12.00% versus a required return on an average stock of 10.00%. Now the required return on an average stock increases by 30.0% (not percentage points). Neither betas nor the risk-free rate change. What would CCC's new required return be

Answer 1

Answer:

CCC's new required rate of return is 16.5%

Explanation:

in the first we need to determine the risk free rate using the Capital Asset Pricing Model formula of Miller and Modgiliani as shown below

required return=Rf+beta*(average market return-Rf)

Rf is the risk free rate that is unknown

Beta is 1.5

average market return is 10%

required rate of return is 12%

Rf?

12%=Rf+1.5*(10%-Rf)

12%=Rf+15%-1.5Rf

1.5Rf-Rf=15%-12%

0.5Rf=3%

Rf=3%/0.5

Rf=6%

Average rate of 10% has now increased by 30% i.e 10%*(1+30%)=13%

Required rate of return=6%+1.5*(13%-6%)

                                      =6%+1.5*7%

                                       =6%+10.5%=16.5%