NuPress Valet has an improved version of its hotel stand.The investment cost is expected to be £72 million and will return £13.5 million for 5 years in net cash ﬂows.The ratio of debt to equity is 1
To 1.The cost of equity is 13%, the cost of debt is 9%, and the tax rate is 34%.The appropriate
Discount rate, assuming average risk, is:

Question

Quizplus · Accepted Answer

To calculate the appropriate discount rate, we need to use the weighted average cost of capital (WACC) formula. Given that the debt-to-equity ratio is 1 to 1, we can assume that both sources of financing contribute equally to the WACC. Therefore, the WACC can be calculated as follows:

WACC = (E/V) x Re + (D/V) x Rd x (1 - T)
where:
E/V = equity as a proportion of the total value of the firm = 1/2
Re = cost of equity = 13%
D/V = debt as a proportion of the total value of the firm = 1/2
Rd = cost of debt = 9%
T = tax rate = 34%

WACC = (1/2) x 13% + (1/2) x 9% x (1 - 0.34) = 9.47%

Therefore, the appropriate discount rate for this investment opportunity is 9.47%. Choice C is the correct answer.

NuPress Valet Has an Improved Version of Its Hotel Stand