The return on US T-Bills is 6%, inflation is 3% and the risk premium of the S&P 500 is 12%. If a stock has a beta of 1.3, what is the expected real rate of return for the stock? O 13.8% O 10.5% O 21.6% O 18.1% O 17.1%
Cost of Capital
Shareholders and investors who invest into the capital of the firm desire to have a suitable return on their investment funding. The cost of capital reflects what shareholders expect. It is a discount rate for converting expected cash flow into present cash flow.
Capital Structure
Capital structure is the combination of debt and equity employed by an organization in order to take care of its operations. It is an important concept in corporate finance and is expressed in the form of a debt-equity ratio.
Weighted Average Cost of Capital
The Weighted Average Cost of Capital is a tool used for calculating the cost of capital for a firm wherein proportional weightage is assigned to each category of capital. It can also be defined as the average amount that a firm needs to pay its stakeholders and for its security to finance the assets. The most commonly used sources of capital include common stocks, bonds, long-term debts, etc. The increase in weighted average cost of capital is an indicator of a decrease in the valuation of a firm and an increase in its risk.
![**Question:**
The return on US T-Bills is 6%, inflation is 3%, and the risk premium of the S&P 500 is 12%. If a stock has a beta of 1.3, what is the expected real rate of return for the stock?
**Options:**
- ○ 13.8%
- ○ 10.5%
- ● 21.6%
- ○ 18.1%
- ○ 17.1%
The highlighted option is **21.6%**.
**Explanation:**
The expected real rate of return can be calculated using the formula:
\[ \text{Expected Return} = \text{Risk-Free Rate} + \beta \times \text{Risk Premium} \]
Where:
- **Risk-Free Rate** is the return on US T-Bills (6%).
- **Beta (β)** is a measure of the stock’s volatility compared to the market (1.3).
- **Risk Premium** is the additional return expected from the market compared to the risk-free rate (12%).
Substitute the values into the formula:
\[ \text{Expected Return} = 6\% + 1.3 \times 12\% \]
\[ \text{Expected Return} = 6\% + 15.6\% \]
\[ \text{Expected Return} = 21.6\% \]
Therefore, the expected real rate of return for the stock is 21.6%.](/v2/_next/image?url=https%3A%2F%2Fcontent.bartleby.com%2Fqna-images%2Fquestion%2Ff2ab050a-d13e-4a73-9fee-dc44d5d071e8%2F09886fd7-8bbe-498c-88ea-4911d3b512d7%2Fj1r95c5_processed.jpeg&w=3840&q=75)
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