13) HR Industries (HRI) has a beta of 1.8, while LR Industries\' (LRI) beta is 0

Question

13) HR Industries (HRI) has a beta of 1.8, while LR Industries' (LRI) beta is 0.6. The risk-free rate is 5.5%, and the required rate of return on a stock with a beta of 1 is 12.5%. The expected rate of inflation built into rRF falls by 1.5 percentage points, the real risk-free rate remains constant, the required return on the market falls to 10.5%, and all betas remain constant. After all of these changes, what will be the difference (in percentage points) in the required returns for HRI and LRI? A. 3.8% B. 0.9% C. 1.5% D. 2.4% E. 3.5%

Explanation / Answer

Rf = 5.5% - 1.5% = 4%

Rhri = 4% + 1.8*(10.5% - 4%) = 15.7%

Rlri = 4% + 0.6*(10.5% - 4%) = 7.9%

Difference = 15.7% - 7.9% = 7.8%

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