Calculate the required rate of return for Mercury Inc. to the nearest .1 Assume that investors expect a 3.0 percent rate of inflation in the future. The real risk-free rate is equal to 5.8 percent and the market risk premium is 9.3 percent. Mercury has a beta of 1.5 , and its realized rate of return has averaged 17.0 percent over the last 5 years.
To calculate the required rate of return for Mercury Inc., we need to use the capital asset pricing model (CAPM) formula:
Required Rate of Return = Real Risk-Free Rate + (Beta x Market Risk Premium)
Step 1: Calculate the real risk-free rate
Given: Real risk-free rate = 5.8 percent
The real risk-free rate is the rate of return on an investment with zero risk in an inflation-free economy. In this case, it is 5.8 percent.
Step 2: Calculate the market risk premium
Given: Market risk premium = 9.3 percent
The market risk premium reflects the additional return investors expect to receive for taking on the risk of investing in the overall market. In this case, it is 9.3 percent.
Step 3: Calculate the required rate of return
Given: Beta = 1.5
Required Rate of Return = 5.8% + (1.5 x 9.3%)
= 5.8% + 13.95%
= 19.75%
To calculate the required rate of return for Mercury Inc., add the real risk-free rate (5.8 percent) to the product of the beta (1.5) and the market risk premium (9.3 percent). The required rate of return is approximately 19.75 percent.