HR Industries (HRI) has a beta of 1.3, while LR Industries\'s (LRI) beta is 0.4.

Question

HR Industries (HRI) has a beta of 1.3, while LR Industries's (LRI) beta is 0.4. The risk-free rate is 6%, and the required rate of return on an average stock is 13%. The expected rate of inflation built into rRF falls by 1.5 percentage points; the real risk-free rate remains constant; the required return on the market falls to 10.5%; and all betas remain constant. After all of these changes, what will be the difference in the required returns for HRI and LRI? Round your answer to two decimal places.

Explanation / Answer

CAPM = Risk free rate + Beta * (return on the market - risk free rate)

Required return HRI = 6 + 1.3 * (13-6) = 15.1

Required return LRI = 6 + 0.4 (13-6) = 8.8

Inflation falls by 1.5% = 6-1.5 = 4.5

Required return HRI = 4.5 + 1.3 * (10.5-6) = 10.22

Required return LRI = 6 + 0.4 (10.5-6) = 7.8

Difference in required return HRI = 15.1 - 10.22 = 4.8%

Difference in required return LRI = 8.8 - 7.8 = 1%

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