An equity analyst has determined that the risk-free rate is 4% and the market ri
ID: 2737063 • Letter: A
Question
An equity analyst has determined that the risk-free rate is 4% and the market risk premium is 6%. What is the required return for Tomtom Corporation with a beta of 1.4? Now assume the risk-free rate (a) increases to 6% and (b) decreases to 3%. How does this impact the required return on the market and the required return for Tomtom Corporation? Now assume that risk-free rate remains constant, but the market risk premium (a) increases to 8% and (b) decreases to 4%. How does this impact the required return on the market and the required return for Tomtom Corporation?
Explanation / Answer
When risk free rate increases to 6% ; required return of tomtom would increase by change in risk free rate = 2%
When risk free rate decreases to 3% ; required return of tomtom would decrease by change in risk free rate = 1%
When market risk premium increases to 8%; change in required return = ( 8 % - 6%) * 1.4 = 2.8% increase
When market risk premium decreases to 4%; change in required return = ( 4%- 6 %) * 1.4 = 2.8% decrease