NuPress Valet has an improved version of its hotel stand.The investment cost is expected to be £72 million and will return £13.5 million for 5 years in net cash flows.The ratio of debt to equity is 1 to 1.The cost of equity is 13%,the cost of debt is 9%,and the tax rate is 34%.The appropriate discount rate,assuming average risk,is:

Question

Quizplus · Accepted Answer

The appropriate discount rate can be calculated using the weighted average cost of capital (WACC) formula:

WACC = (E/V) x Re + (D/V) x Rd x (1 - T)

where:
E = market value of equity
D = market value of debt
V = E + D
Re = cost of equity
Rd = cost of debt
T = tax rate

Given:
E = D = £36 million (since debt-to-equity ratio is 1:1)
Re = 13%
Rd = 9%
T = 34%

V = 2E (since E = D)
V = 2 x 36 million = 72 million

WACC = (36/72) x 0.13 + (36/72) x 0.09 x (1 - 0.34) = 0.0947 or 9.47%

Therefore, the best choice is C.

NuPress Valet Has an Improved Version of Its Hotel Stand