An asset's beta can be used to compute its discount rate for an NPV calculation because the discount rate is equal to:

Question

Quizplus · Accepted Answer

The discount rate is equal to the risk-free rate plus the asset's beta multiplied by the market risk premium, which is the difference between the market return and the risk-free rate. This can be expressed as r = r_f + b(r_m - r_f). Rearranging the equation yields r = r_f + b(r_m - r_f) = r_f + br_m - br_f. This is the same equation as choice D, where r__f represents the risk-free rate, r__m represents the market return, and r__f - r__m represents the risk premium.

An Asset's Beta Can Be Used to Compute Its Discount