The Red Hen currently has a debt-to-equity ratio of 0.45,its cost of equity is 13.3 percent,and its beta is 1.49.The pretax cost of debt is 7.2 percent,the tax rate is 35 percent,and the risk-free rate is 3.1 percent.The firm's target debt-to-equity ratio is 0.4.What discount rate should be assigned to a new project the firm is considering if the project is equally as risky as the overall firm and will be financed solely with debt?

Question

Quizplus · Accepted Answer

A project's discount rate should be computed based on the company's target debt-to-equity ratio not on the financing specific to the project.
Discount rate = (1 / 1.4)(0.133)+ (0.4 / 1.4)(0.072)(1 − 0.35)= 0.1084,or 10.84%

The Red Hen Currently Has a Debt-To-Equity Ratio of 0