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Question
Dixon Food's stock has a beta of 1.4, while Clark Caf's stock has a beta of 0.7. Assume that the risk-free rate, rRF, is 5.5% and the market risk premium, (rM - rRF), equals 4%. Which of the following statements is CORRECT?
a. If the market risk premium increases but the risk-free rate remains unchanged, Dixon's required return will increase because it has a beta greater than 1.0 but Clark's required return will decline because it has a beta less than 1.0.
b. Since Dixon's beta is twice that of Clark's, its required rate of return will also be twice that of Clark's.
c. If the risk-free rate increases while the market risk premium remains constant, then the required return on an average stock will increase.
d. If the market risk premium decreases but the risk-free rate remains unchanged, Dixon's required return will decrease because it has a beta greater than 1.0 and Clark's will also decrease, but by more than Dixon's because it has a beta less than 1.0.
e. If the risk-free rate increases but the market risk premium remains unchanged, the required return will increase for both stocks but the increase will be larger for Dixon since it has a higher beta.
Answer
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