Rate of Returns

If RF = 6 percent, b = 1.3, and the ERP= 6.5 percent, compute Ke (the required rate of return).

Ke = 6% + 1.3(6.5%)

Ke = 14.45%

If in problem 2 the beta ( b ) were 1.9 and the other values remained the same, what is the new value of Ke ? What is the relationship between a higher beta and the required rate of return (Ke )?

Assume the same facts as in problem 2, but with an ERP of 9 percent. What is the new value for Ke ? What does this tell you about investors' feelings toward risk based on the new ERP?

RF (Risk-free rate) = (1 + Real rate) (1 + Expected rate of inflation) -1 (7â?"1)

Using Formula above, compute RF (risk-free rate). The real rate of return is 3 percent and the expected rate of inflation is 5 percent.