Calculate the required rate of return for Mercury, Inc., assuming that (1) investors expect a 4.0% rate of inflation in the future, (2) the real risk-free rate is 3.0%, (3) the market risk premium is 5.0%, (4) Mercury has a beta of 1.00, and (5) its realized rate of return has averaged 15.0% over the last 5 years.
A) 10.29%
B) 10.83%
C) 11.40%
D) 12.00%
E) 12.60%

Question

Quizplus · Accepted Answer

The required rate of return can be calculated using the Capital Asset Pricing Model (CAPM): Required return = Risk-free rate + (Beta * Market risk premium). The risk-free rate is the sum of the real risk-free rate and the expected inflation rate, which is 3.0% + 4.0% = 7.0%. Therefore, the required return = 7.0% + (1.00 * 5.0%) = 12.0%.

Calculate the Required Rate of Return for Mercury, Inc