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Mikkelson Corporation's stock had a required return of 11.75% last year, when the risk-free rate was 5.50% 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.) 14.38% 14.74% 15.11% 15.49% 15.87%

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Shahzaibfaraz

Answer:

The new required rate of return is 14.38%

Explanation:

The old required rate of return was 11.75%.

Using the SML equation and plugging in the known components, we will calculate the beta for the stock.

0.1175 = 0.055 + β * 0.0475

(0.1175 - 0.055) / 0.0475 = β

β or beta = 1.316

The same equation will be used to calculate the new required rate of return.

The beta and risk free rate are same.

The new market risk premium is 6.75% (4.75 + 2)

The new required rate of return (r) is,

r = 0.055 + 1.316 * 0.0675

r = 0.14383 or 14.383%

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