Question

Mikkelson Corporation's stock had a required return of 12.50% last year, when the risk-free rate was 3% and the market risk premium was 4.75%.
Then an increase in investor risk aversion caused the market risk premium to rise by 2%. The risk-free rate and the firm's beta remain unchanged.

What is the company's new required rate of return?

(Hint: First calculate the beta, then find the required return.) Do not round your intermediate calculations.

a. 16.50%

b. 13.04%

c. 12.87%

d. 12.71%

e. 14.36%

Answer 1

Answer:

a. 16.50%

Explanation:

Find the beta as of last year using CAPM;

CAPM ; r = risk free + beta(Market risk premium)

0.125 = 0.03 + beta(0.0475)

Subtract 0.03 from both sides;

0.125-0.03 = 0.0475beta

0.095 = 0.0475beta

Divide both sides by 0.0475;

0.095/0.0475 = beta

beta = 2

Next, use CAPM again to find the new required return with a market risk premium is 4.75%+ 2% = 6.75%

r =  0.03 + 2(0.0675)

r = 0.03 + 0.135

r = 0.165 or 16.5%

Therefore, the new required return is 16.5%