Silo Mills is an all-equity financed firm that has a beta of 1.18 and a cost of equity of 12.2 percent. The risk-free rate of return is 2.9 percent. The firm is currently considering a project that has a beta of 1.03 and a project life of six years. What discount rate should be assigned to this project?

Question

Quizplus · Accepted Answer

The discount rate that should be assigned to the project is the cost of equity adjusted for the project's beta.

First, we need to calculate the cost of equity for the project using the capital asset pricing model (CAPM):

Cost of equity = risk-free rate + beta x (market risk premium)
Cost of equity = 2.9% + 1.03 x (12.2% - 2.9%)
Cost of equity = 11.02%

Next, we need to adjust the cost of equity for the project's beta:

Discount rate = cost of equity x (project beta / firm beta)
Discount rate = 11.02% x (1.03 / 1.18)
Discount rate = 9.60%

Therefore, the discount rate that should be assigned to this project is 9.60%.

Note: Option A is incorrect because it is too high, option C is incorrect because it is lower than the cost of equity for the firm, and options D and E are incorrect because they are too high.

Silo Mills Is an All-Equity Financed Firm That Has a Beta