Question

Reus me han WALL 13. Oakdale Furniture, Inc. has a beta coefficient of 0.7 and a required rate of return of 15 percent. The market risk premium is currently 5 percent. We expect the inflation premium to increase 2 percentage points and Oakdale to acquire assets, which will increase its beta by 50 percent. (a) What was the old risk free rate and the new expected risk free rate? (10) (b) What is Oakdale's new beta? (1 pt) (c) What is Oakdale's new required rate of return? (1 pt)

Answer 1

According to the CAPM,

Required Return = Risk-free Rate + [Beta * Market Risk Premium]

a). Before:

15% = Risk-free Rate + [0.7 * 5%]

15% = Risk-free Rate + 3.5%

Risk-free Rate = 15% - 3.5% = 11.5%

New Risk-free Rate = Old Risk-free Rate + Inflation Premium

= 11.5% + 2% = 13.5%

b). New Beta = Old Beta * (1 + 0.50)

= 0.7 * 1.50 = 1.05

c). New Required Return = 13.5% + [1.05 * 5%]

= 13.5% + 5.25% = 18.75%