How is the Required Rate of Return calculated?

The required rate of return is calculated by combining the risk-free rate with additional premiums that account for the risks associated with investing in a particular asset or investment. The correct answer identifies the risk-free rate as the foundational baseline for returns, which is the return expected from an investment with zero risk, typically represented by government bonds.

In choice C, the inclusion of both a liquidity premium and a required risk premium is essential. The liquidity premium compensates investors for the risk associated with the difficulty of selling an asset without influencing its price significantly. Meanwhile, the required risk premium reflects the compensation for taking on additional risks, such as market volatility or credit risks that exceed that of a risk-free investment.

By contrasting this with other options, choice A lacks comprehensiveness, focusing only on dividends without considering risk factors. choice B inaccurately incorporates inflation in a way that does not align with the standard formula for the required rate of return. Additionally, choice D mistakenly includes market capitalization, which is not a factor in calculating the required return.

Therefore, by adding both the liquidity premium and the required risk premium to the risk-free rate, the answer accurately reflects the complexities involved in determining the required rate of return based on various risk dimensions present in the investment environment.