CCC Corp 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 CCC's new required return be?
A)14.89%
B)15.68%
C)16.50%
D)17.33%
E)18.19%

Question

Quizplus · Accepted Answer

Using the Capital Asset Pricing Model (CAPM) formula, the new required return would be:

New Required Return = Risk-Free Rate + Beta * (New Market Return - Risk-Free Rate)

New Market Return = 10% + 30% = 13%

New Required Return = 0% + 1.5 * (13% - 0%) = 19.5%

However, the question specifies that CCC's beta does not change, so we can use the original beta of 1.5.

New Required Return = 0% + 1.5 * (13% - 0%) = 19.5%

Now we need to adjust for the fact that the required return on an average stock has increased by 30%.

Adjustment Factor = New Required Return / Old Required Return
Adjustment Factor = 19.5% / 12% = 1.625

New CCC Required Return = Old CCC Required Return * Adjustment Factor
New CCC Required Return = 12% * 1.625 = 19.50%

Finally, we subtract the 30% increase in required return on an average stock to arrive at the new required return for CCC.

New CCC Required Return = 19.50% - 30% = 13.65%

Therefore, the closest answer choice is C) 16.50%.

CCC Corp Has a Beta of 1