Calculate the required rate of return for Campbell Corp. common stock. The stock has a beta of 1.3 and Campbell is considered a large capitalization stock. Current long-term government bonds are yielding 5.0%. (Refer to table 1-3 for equity risk premiums of large stocks).
For CAPM, the required rate of return = Risk-free rate + Beta * Equity Risk premium
Using Table 1-3 for historical equity risk premiums we find an equity risk premium of 4.4% when long-term government bonds are compared to large common stock returns.
The required rate of return for Campbell Corp. = 5.0% + 1.3*4.4% = 9.97%
a. How would your required rate of return change if you used U.S. Treasury bills for your risk-free rate? Assume the current yield on T-bills is 1.25 percent. This is an artificially low rate because the Federal Reserve is trying to stimulate the economy out of a recession.
b. How would this difference in required returns affect the value of any cash flow you would evaluate?