The NuPress Valet Co.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

To find the appropriate discount rate, we need to find the weighted average cost of capital (WACC).

First, we need to calculate the weights of debt and equity in the capital structure:

Weight of Debt = Debt / (Debt + Equity) = $36 million / ($36 million + $36 million) = 0.5
Weight of Equity = Equity / (Debt + Equity) = $36 million / ($36 million + $36 million) = 0.5

Next, we can use the WACC formula:

WACC = (Cost of Equity x Weight of Equity) + (Cost of Debt x Weight of Debt) x (1 – Tax Rate)

WACC = (0.13 x 0.5) + (0.09 x 0.5) x (1 – 0.34)
WACC = 0.0947 or 9.47%

Therefore, the appropriate discount rate for this project is 9.47%. Choice C is the correct answer.