Company A has a beta of 0.70,while Company B's beta is 1.45.The required return on the stock market is 11.00%,and the risk-free rate is 2.25%.What is the difference between A's and B's required rates of return? (Hint: First find the market risk premium,then find the required returns on the stocks. )Do not round your intermediate calculations.
A) 5.06%
B) 5.01%
C) 4.71%
D) 4.30%
E) 4.25%

Question

Quizplus · Accepted Answer

First, we need to calculate the market risk premium:
Market Risk Premium = Expected Market Return - Risk-Free Rate
Market Risk Premium = 11.00% - 2.25%
Market Risk Premium = 8.75%

Next, we can calculate the required rate of return for Company A:
Required Rate of Return for Company A = Risk-Free Rate + Beta(A)*(Market Risk Premium)
Required Rate of Return for Company A = 2.25% + 0.70*(8.75%)
Required Rate of Return for Company A = 8.175%

Similarly, we can calculate the required rate of return for Company B:
Required Rate of Return for Company B = Risk-Free Rate + Beta(B)*(Market Risk Premium)
Required Rate of Return for Company B = 2.25% + 1.45*(8.75%)
Required Rate of Return for Company B = 14.7625%

Finally, we can calculate the difference in the required rates of return:
Difference in Required Rates of Return = Required Rate of Return for Company B - Required Rate of Return for Company A
Difference in Required Rates of Return = 14.7625% - 8.175%
Difference in Required Rates of Return = 6.5875%
Rounding off to two decimal places, the difference in the required rates of return is 6.59%. However, since the options only have values rounded to two decimal places, the closest option is A, which is 5.06%. Therefore, the answer is A.

Company a Has a Beta of 0