DHF Company has a beta of 1.5 and is currently in equilibrium. The required rate of return on the stock is 12.00% versus a required return on an average stock of 10.00%. Now the required return on an average stock increases by 30.0% (not percentage points). Neither betas nor the risk-free rate change. What would DHF's new required return be

The new required return for DHF Company would be 16.5%

Explanation:

Provided data;

beta = 1.5 and it's at equilibrium

required rate of return = 12.00%

required return on an average stock = 10.00%

increase in required return on an average stock = 30.0%

Solve:

To determine the risk-free rate;

= (Required rate of return for DHF company - beta × return on average stock) ÷ (1 - beta)

= (12% - 1.5 × 10) ÷ 1 - 1.5

= (12% - 15%) ÷ 1 - 1.5

= -3% ÷ (-0.5)

= 6%

The revised return on an average stock  = Existing required return on an average stock × (1 + percentage increase)

= 10% × (1 + 30%)

= 10% × 1.30

= 13%

The revised market risk premium = Revised return on an average stock - risk-free rate

= 13% - 6%

= 7%

The new required return for DHF Company  = Risk-free rate + (beta × revised market risk premium)

= 6% + (1.5 × 7%)

= 6% + 10.5%

= 16.5%

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