Question: 1. Using Formula 7 1 on page 165, compute R F (risk-free rate). The real rate of return is 3 percent and the expected rate

1. Using Formula 71 on page 165, compute R_F (risk-free rate). The real rate of return is 3 percent and the expected rate of inflation is 5 percent.

2. If R_F = 6 percent, b = 1.3, and the ERP = 6.5 percent, compute K_e (the required rate of return). ERP = Equity Risk Premium.

3. If in problem 2 the beta (b) were 1.9 and the other values remained the same, what is the new value of K_e? What is the relationship between a higher beta and the required rate of return (K_e)?

4. Assume the same facts as in problem 2, but with an ERP of 9 percent. What is the new value for K_e? What does this tell you about investors feelings toward risk based on the new ERP?

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