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27 May, 18:16

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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  1. 27 May, 20:10
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    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%
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