Question

Nagel Equipment has a beta of 0.88 and an expected dividend growth rate of 4.00% per year. The T-bill rate is 4.00%, and the T-bond rate is 5.25%. The annual return on the stock market during the past 4 years was 10.25%. Investors expect the average annual future return on the market to be 14.75%. Using the SML, what is the firm's required rate of return? Do not round your intermediate calculations. a. 11.57% b. 14.70% c. 12.25% d. 12.11% e. 13.61%

Answer 1

Answer:

Option (e) is correct.

Explanation:

Given that,

Beta = 0.88

Expected dividend growth rate = 4.00% per year

T-bond rate = 5.25% (The treasury bonds are always the risk free rate)

Average annual future return on the market = 14.75%

Required rate of return:

= Risk free rate + Beta × (Market rate - Risk free rate)

= 5.25 + 0.88 × (14.75 - 5.25)

= 5.25 + 0.88 × 9.5

= 5.25 + 8.36

= 13.61%