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?

Question

Vito

Business

31 January, 10:10

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?

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Answers (1)

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Isis House · Answer 1

The discount rate should Honest Abe's use if it considers a project that involves the manufacturing of furniture is 12.46%

Explanation:

In this question, w e use the Capital Asset Pricing model method, which is shown below:

Expected return = Risk-free rate of return + Beta * market risk premium

= 3.5% + 1.12 * 8%

= 3.5% + 8.96%

= 12.46%

In this we use the Integral design beta not the Honest Abe beta