Answer (B) is correct. The required rate of return on equity capital can be estimated with the capital asset pricing model (CAPM). CAPM consists of adding the risk-free rate (i.e., the return on government securities, denoted RF) to the product of the beta coefficient (a measure of the issuer’s risk and the difference between the market return and the risk-free rate (denoted RM – RF, referred to as the risk premium). Below is the basic equilibrium equation for the CAPM: Required rate of return = RF + ?(RM – RF) In this situation, the risk premium is 5% (10% – 5%). Thus, the required rate of return when the beta coefficient is 1.2 is 11% [5% + (1.2 × 5%)], and when the beta
coefficient is 1.5, the required rate is 12.5% [5% + (1.5 × 5%)]. This is an increase of 1.5% (12.5% – 11%).