HR Industries (HRI) has a beta of 1.2, while LR Industries\' (LRI) beta is 0.6.

Question

HR Industries (HRI) has a beta of 1.2, while LR Industries' (LRI) beta is 0.6. 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 to two decimal places)

I got my answer 7.80%. Is that correct?

Explanation / Answer

Difference in the required returns for HRI and LRI = 3.6%

But your answer is 7.80% which is incorrect.

Explanation;

First of all let’s calculate rRF;

rRF = r + IP

rRF = 6% - 1.5% = 4.5%

Now, let’s calculate required returns for HRI and LRI;

Required return for HRI = 4.5% + (10.5% - 4.5%) * 1.2

Required return for HRI = 4.5% + (6%) * 1.2

Required return for HRI = 4.5% + 7.2%

= 11.7%

Required return for LR = 4.5% + (10.5% - 4.5%) * 0.6

Required return for HRI = 4.5% + (6%) * 0.6

Required return for HRI = 4.5% + 3.6%

= 8.1%

The difference in the required returns for HRI and LRI (11.7% - 8.1%) = 3.6%

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