Answer:
7.83%
Explanation:
To calculate the required rate of return we need to portfolio beta.
Portfolio beta is the average beta calculated on the basis of weightage of each investment. The beta of every investment is multiplied with the weightage of each investment in a portfolio. All the value is added to get the portfolio beta.
Total Portfolio after addition = $10 million + $14.5 million = $24.5 million
Portfolio Beta = ( Existing beta x Existing Weightage) + ( New Stock beta x New Stock Weightage)
Portfolio Beta = ( 1.05 x 10/24.5 ) + ( 0.65 x 14.5/24.5 )
Portfolio Beta = 0.43 + 0.38 = 0.81
We will use CAM to calculate the revised required rate of return
Capital asset pricing model measure the expected return on an asset or investment. it is used to make decision for addition of specific investment in a well diversified portfolio.
Formula for CAPM
First Calculate the market premium from existing portfolio
Required Rate of return = Risk free rate + beta ( market return - risk free rate )
Required Rate of return = Rf + β ( Rm - Rf )
9.50% = 2.2% + 1.05 ( Mp )
9.5% - 2.2% = 1.05 ( Mp )
7.3% = 1.05 ( Mp )
Mp = 7.3% / 1.05
Mp = 6.95%
Place this Market premium in revised rate of return calculation
Cost of Capital = Rf + β ( Rm - Rf )
Cost of Capital = 2.20% + 0.81 ( 6.95% )
Cost of Capital = 7.83%
