Answer:
The new required return for DHF Company would be 16.5%
Explanation:
Provided data;
beta = 1.5 and it's at equilibrium
required rate of return = 12.00%
required return on an average stock = 10.00%
increase in required return on an average stock = 30.0%
Solve:
To determine the risk-free rate;
= (Required rate of return for DHF company - beta × return on average stock) ÷ (1 - beta)
= (12% - 1.5 × 10) ÷ 1 - 1.5
= (12% - 15%) ÷ 1 - 1.5
= -3% ÷ (-0.5)
= 6%
The revised return on an average stock = Existing required return on an average stock × (1 + percentage increase)
= 10% × (1 + 30%)
= 10% × 1.30
= 13%
The revised market risk premium = Revised return on an average stock - risk-free rate
= 13% - 6%
= 7%
The new required return for DHF Company = Risk-free rate + (beta × revised market risk premium)
= 6% + (1.5 × 7%)
= 6% + 10.5%
= 16.5%
The new required return for DHF Company will be 16.5%.
Given information
Beta = 1.5 and it's at equilibrium
Required rate of return = 12.00%
Required return on an average stock = 10.00%
increase in required return on an average stock = 30.0%
Risk-free rate = (Required rate of return for DHF company - beta × return on average stock) ÷ (1 - beta)
Risk-free rate = (12% - 1.5 × 10) ÷ 1 - 1.5
Risk-free rate = (12% - 15%) ÷ 1 - 1.5
Risk-free rate = -3% ÷ (-0.5)
Risk-free rate = 6%
Revised return on average stock = Existing required return on an average stock × (1 + percentage increase)
Revised return on average stock = 10% × (1 + 30%)
Revised return on average stock = 10% × 1.30
Revised return on average stock = 13%
Revised market risk premium = Revised return on an average stock - risk-free rate
Revised market risk premium = 13% - 6%
Revised market risk premium = 7%
New required return = Risk-free rate + (beta × revised market risk premium)
New required return = 6% + (1.5 × 7%)
New required return = 6% + 10.5%
New required return = 16.5%
In conclusion, the new required return for DHF Company will be 16.5%.
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