Question

Honest Abe's is a chain of furniture retail stores. Integral Designs is a furniture maker and a supplier to Honest Abe's. Honest Abe's has a beta of 1.38 as compared to Integral Designs' beta of 1.12. Both firms carry no debt, i.e., are 100% equity-financed. The risk-free rate of return is 3.5 percent and the market risk premium is 8 percent. What discount rate should Honest Abe's use if it considers a project that involves the manufacturing of furniture?

Answer 1

Answer:

The discount rate is 12.46%

Explanation:

In this question, we use the Capital asset pricing model (CAPM).

The formula and computation of the discount rate is shown below:

= Risk-free rate of return + (Beta × Market risk premium)

= 3.5% + (1.12 × 8%)

= 3.5% + 8.96%

= 12.46%

Since we have to compute the discount rate for the project that involves the manufacturing of furniture, so we have to use the Integral designs beta instead of the Honest Abe because Integral design is a furniture maker