You are given the following information for Wine and Cork Enterprises (WCE): rRF = 2%; rM = 10%; RPM = 8%, and beta = 1.1 What is WCE's required rate of return? Round your answer to 2 decimal places. Do not round intermediate calculations. % If inflation increases by 2% but there is no change in investors' market risk premium, what is WCE's required rate of return now? Round your answer to two decimal places. Do not round intermediate calculations. % Assume now that there is no change in inflation, but market risk premium increases by 2%. What is WCE's required rate of return now? Round your answer to two decimal places. Do not round intermediate calculations. % If inflation increases by 2% and market risk premium increases by 2%, what is WCE's required rate of return now? Round your answer to two decimal places
Risk and return
Before understanding the concept of Risk and Return in Financial Management, understanding the two-concept Risk and return individually is necessary.
Capital Asset Pricing Model
Capital asset pricing model, also known as CAPM, shows the relationship between the expected return of the investment and the market at risk. This concept is basically used particularly in the case of stocks or shares. It is also used across finance for pricing assets that have higher risk identity and for evaluating the expected returns for the assets given the risk of those assets and also the cost of capital.
The security market line (SML) is an equation that shows the relationship between risk as measured by beta and the required
The SML line can change due to expected inflation and risk aversion. If inflation changes, then the SML plotted on a graph will shift up or down parallel to the old SML. If risk aversion changes, then the SML plotted on a graph will rotate up or down becoming more or less steep if investors become more or less risk averse. A firm can influence market risk (hence its beta coefficient) through changes in the composition of its assets and through changes in the amount of debt it uses.
Quantitative Problem: You are given the following information for Wine and Cork Enterprises (WCE):
rRF = 2%; rM = 10%; RPM = 8%, and beta = 1.1
What is WCE's required rate of return? Round your answer to 2 decimal places. Do not round intermediate calculations.
%
If inflation increases by 2% but there is no change in investors' market risk premium, what is WCE's required rate of return now? Round your answer to two decimal places. Do not round intermediate calculations.
%
Assume now that there is no change in inflation, but market risk premium increases by 2%. What is WCE's required rate of return now? Round your answer to two decimal places. Do not round intermediate calculations.
%
If inflation increases by 2% and market risk premium increases by 2%, what is WCE's required rate of return now? Round your answer to two decimal places. Do not round intermediate calculations.
%
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