Value 4.0% 6.0% CAPM Elements Risk-free rate (RF) Market risk premium (RPM) Happ

Question

Value 4.0% 6.0% CAPM Elements Risk-free rate (RF) Market risk premium (RPM) Happy Corp. stock's beta Required rate of return on Happy Corp. stock | | 0.6 7.6% | An analyst believes that inflation is going to increase by 2.0% over the next year, while the market risk premium will be unchanged. The analyst uses the Capital Asset Pricing Model (CAPM). The following graph plots the current SML Calculate Happy Corp.'s new required return. Then, on the graph, use the green points (rectangle symbols) to plot the new SML suggested by this analyst's prediction. Happy Corp.'s new required rate of return is Tool tip: Mouse over the points on the graph to see their coordinates. 9.6% REQUIRED RATE OF RETURN Percent) New SML 18 12 0.0 0.4 0.8 1.2 1.8 2.0 RISK IBetal

Explanation / Answer

The graph shows SML

whose equation is as below:

Required retunr=risk free return + beta* market risk premium

Here, risk free return =4%

market risk premium=6%

So, equation would be

Required return=4 + beta* 6

So, as we see for risk free, beta=0..required return=4%

similarly, for beta=2..required return=4+2*6=16%

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