Jeb's Automotive has a beta of 1.0 and a cost of equity of 14 percent. The risk-free rate of return is 5 percent. Jeb's is considering a project with a beta of .75. An appropriate discount rate for the
Project is:

Question

Quizplus · Accepted Answer

Using the CAPM formula:

Cost of equity = risk-free rate + Beta * (Market risk premium)

Given:

Beta of Jeb's Automotive = 1.0
Cost of equity of Jeb's Automotive = 14%
Risk-free rate = 5%
Beta of the project = 0.75

Market risk premium = Cost of equity of Jeb's Automotive - Risk-free rate = 14% - 5% = 9%

Plugging in the values:

Cost of equity for the project = 5% + 0.75 * 9% = 11.75%

Therefore, the appropriate discount rate for the project is 11.75%.

Jeb's Automotive Has a Beta of 1