Question

Brodkey Shoes has a beta of 1.30, the T-bill rate is 3.00%, and the T-bond rate is 6.5%. The annual return on the stock market during the past 3 years was 15.00%, but investors expect the annual future stock market return to be 13.00%. Based on the SML, what is the firm's required return?

Answer 1

Answer:

14.95%

Explanation:

First we will determine the market risk premium which shall be calculated as follows:

Market risk premium=Expected annual return of market-Risk free return

In the given question

Expected annual return of market=13%

Risk free return=Return on T-Bonds=6.5%

Market risk premium=13%-6.5%=6.5%

Based on above Market risk premium, the firm required return shall be calculated as follows:

Firm required return=Risk free return+Beta*Market risk premium

                                   =6.5%+1.30*6.5%

                                   =14.95%