Average stocks are yielding 7.0%, while short term treasuries return 3.0%. Marshall Inc. has a beta of 1.3 and is considering a new venture into an industry with direct competitors who have betas that average 1.8. What discount rate should Marshall use in evaluating the cash flows from this project?

Question

Quizplus · Accepted Answer

The discount rate can be calculated using the Capital Asset Pricing Model (CAPM), which is: Risk-Free Rate + Beta * (Market Return - Risk-Free Rate). Given the risk-free rate (short term treasuries) is 3.0%, the market return (average stocks) is 7.0%, and the beta for the project (since it's in an industry with an average beta of 1.8, we use 1.8 instead of Marshall's beta of 1.3) is 1.8, the calculation is: 3.0% + 1.8 * (7.0% - 3.0%) = 3.0% + 1.8 * 4.0% = 3.0% + 7.2% = 10.2%.

Average Stocks Are Yielding 7