Real Risk Free Rate (RFR) = RFRn - Inflation
RFRn = Real RFR + Inflation = 2.5 + 3.5 = 6%
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Using the Capital Asset Pricing Model,
RRR = RFRn + βstock( Rm - RFRn),
whereby
RRR - Required Rate of Return,
RFRn - Nominal Risk Free Rate (6%),
βstock - Beta of the Stock (1.7), which is a measure of the risk of the stock with comparison to the market as a whole,
Rm - Return of the Market as a whole.
( Rm - RFRn) - Market Risk Free Premium (6.5%), or the return above the RFR
Therefore RRR = 6 + 1.7(6.5) = 17.05%
Hope this helps.
Calculate the required rate of return for Manning Enterprises assuming that investors expect a 3.5% rate of inflation in the future. The real risk-free rate is 2.5% (assume there is no maturity risk premium), and the market risk premium is 6.5%. Manning has a beta of 1.7.
