Mikkelson Corporation's stock had a required return of 12.50% last year, when the risk-free rate was 3% 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

Question

Victoria Abbott

Business

2 April, 07:50

Mikkelson Corporation's stock had a required return of 12.50% last year, when the risk-free rate was 3% 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

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Answers (1)

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Chum · Answer 1

Beta = 2

New required rate of return = 16.50%

Explanation:

In this question, we apply the Capital Asset Pricing Model (CAPM) formula which is shown below

Expected rate of return = Risk-free rate of return + Beta * (Market rate of return - Risk-free rate of return)

12.50% = 3% + Beta * 4.75%

12.50% - 3% = Beta * 4.75%

So, the beta would be 2

The (Market rate of return - Risk-free rate of return) is also known as the market risk premium

Now the required rate of return would be

= 3% + 2 * 6.75%

= 3% + 13.50%

= 16.50%