Get premium membership and access questions with answers, video lessons as well as revision papers.
The required rate of return (Ri) is the minimum rate of return that a project must generate if it has to
receive funds. It’s therefore the opportunity cost of capital or returns expected from the second best
alternative. In general,
Required Rate of Return = Risk-free rate + Risk premium
Risk free rate is compensation for time and is made up of the real rate of return (Rr) and the inflation
premium (IRp). The risk premium is compensation for risk of financial actions reflecting:
- The riskiness of the securities caused by term to maturity
- The security marketability or liquidity
- The effect of exchange rate fluctuations on the security, etc.
The required rate of return can therefore be expressed as follows:
Rj = Rr +IRp +DRp +MRp + LRp + ERp + SRp + ORp.
Where:
• Rr is the real rate of return that compensate investors for giving up the use of their funds in an
inflation free and risk free market.
• IRp is the Inflation Risk Premium which compensates the investor for the decrease in purchasing
power of money caused by inflation.
• DRp is the Default Risk Premium which compensates the investor for the possibility that users of
funds would be unable to repay the debts.
• MRp is the Maturity Risk Premium which compensates for the term to maturity.
• LRp is the Liquidity Risk Premium which compensates the investor for the possibility that the
securities given are not easily marketable (or convertible to cash).
• ERp is the Exchange Risk Premium which compensates the investors for the fluctuation in exchange
rate. This is mainly important if the funds are denominated in foreign currencies.
• SRp is the Sovereign Risk Premium which compensates the investors for the possibility of political
instability in the country in which the funds have been provided.
• ORp is the Other Risk Premium e.g. the type of product, the type of market, etc.
Kavungya answered the question on April 13, 2021 at 06:33
- Define the term financial management.(Solved)
Define the term financial management.
Date posted: April 13, 2021. Answers (1)
- Explain how to calculate WACC in financial management(Solved)
Explain how to calculate WACC in financial management
Date posted: June 27, 2019. Answers (1)
- What are the benefits and challenges with the implantation of a Material requirement planning (MRP) system?(Solved)
What are the benefits and challenges with the implantation of a Material requirement planning (MRP) system?
Date posted: June 1, 2019. Answers (1)
- List the importance of management in an organization(Solved)
List the importance of management in an organization.
Date posted: March 7, 2019. Answers (1)
- List and explain the 14 principles of management(Solved)
List and explain the 14 principles of management
Date posted: March 5, 2019. Answers (1)
- Define management theory and list the advantages of studying it(Solved)
Define management theory and list the advantages of studying it.
Date posted: March 5, 2019. Answers (1)
- Identify 6 factors a firm must consider when designing dividend policies.(Solved)
Identify 6 factors a firm must consider when designing dividend policies.
Date posted: February 12, 2019. Answers (1)
- State the alternative dividend policies a firm may adopt.(Solved)
State the alternative dividend policies a firm may adopt.
Date posted: February 12, 2019. Answers (1)
- The following six have been submitted for inclusion in 1998 capital expenditure budget for
Limuru Ltd.(Solved)
The following six have been submitted for inclusion in 1998 capital expenditure budget for
Limuru Ltd.
Required:
(a) Rates of return (to the nearest half percent) for projects B, C and D and a ranking of all
projects in descending order.
b) Compute the payback reciprocal for projects B and C.
(c) Compute the N.P.V of each project using 16% as discount rate and rank all projects
Date posted: February 12, 2019. Answers (1)
- Identify the various methods of issuing new ordinary shares to shareholders.(Solved)
Identify the various methods of issuing new ordinary shares to shareholders.
Date posted: February 12, 2019. Answers (1)
- Why does ordinary share capital have a high cost relative to debt capital?(Solved)
Why does ordinary share capital have a high cost relative to debt capital?
Date posted: February 12, 2019. Answers (1)
- Using illustrative examples, explain the payback period and accounting rate of return methods of
projects appraisal and explain the advantages and disadvantages of each method.(Solved)
Using illustrative examples, explain the payback period and accounting rate of return methods of
projects appraisal and explain the advantages and disadvantages of each method.
Date posted: February 12, 2019. Answers (1)
- What practical problems are faced by finance managers in capital budgeting decisions.(Solved)
What practical problems are faced by finance managers in capital budgeting decisions.
Date posted: February 12, 2019. Answers (1)
- What are the features of a sound appraisal technique?(Solved)
What are the features of a sound appraisal technique?
Date posted: February 12, 2019. Answers (1)
- The Altman formula for prediction of bankruptcy is given as follows:(Solved)
The Altman formula for prediction of bankruptcy is given as follows:
Date posted: February 12, 2019. Answers (1)
- The following information is provided in respect to the affairs of Pote Limited which prepares
its account on the calendar year basis.(Solved)
The following information is provided in respect to the affairs of Pote Limited which prepares
its account on the calendar year basis.
Required:
a) Calculate the rate of stock turnover expressed:
i) as a ratio;
ii)in days for each of the years 1994 and 1995.
b) Calculate the rate of collection of debtors, in days, for each of the years 1994 and 1995.
(3 marks)
c) Calculate the rate of payment to creditors, in days, for each year 1994 and 1995.
(3 marks)
d) Show the cash operating cycle for each year.
e) Comment on the results.
Date posted: February 12, 2019. Answers (1)
- Mr. Castro uses a 20% hatch system of timing when to invest in a stock market. In a
given year, the top of a given share...(Solved)
Mr. Castro uses a 20% hatch system of timing when to invest in a stock market. In a
given year, the top of a given share was Sh.150 and its bottom was Sh.90. During the
year, the company paid an interim DPS of Sh.1.50 and a final DPS of Sh.4.50.
Determine the % return on investment.
Date posted: February 12, 2019. Answers (1)
- With reference to capital market, define the following terms:
i) Contango operation
ii) Backwardation
iii) Stags
iv) Role of investment banker(Solved)
With reference to capital market, define the following terms:
i) Contango operation
ii) Backwardation
iii) Stags
iv) Role of investment banker
Date posted: February 12, 2019. Answers (1)
- What are the advantages of having a farmers' bank compared with an ordinary
commercial bank in the provision of services to farmers(Solved)
What are the advantages of having a farmers' bank compared with an ordinary
commercial bank in the provision of services to farmers
Date posted: February 12, 2019. Answers (1)
- Why do different sources of finance have different costs?(Solved)
Why do different sources of finance have different costs?
Date posted: February 12, 2019. Answers (1)