Question

decker's is an all-equity financed chain of retail furniture stores. furniture fashions produces furniture and is the primary supplier to decker's. decker's has a beta of 1.62 as compared to furniture fashions' beta of 1.43. the risk-free rate of return is 3.1 percent and the market risk premium is 7.6 percent. what discount rate should decker's use if it considers a project that involves the manufacturing of furniture?

Answer 1

To calculate the discount rate that Decker's should use for a project involving the manufacturing of furniture, we can use the Capital Asset Pricing Model (CAPM). Decker's should use a discount rate of 11.775% for the project involving manufacturing furniture.

Step-by-step explanation:

To calculate the discount rate that Decker's should use for a project involving the manufacturing of furniture, we can use the Capital Asset Pricing Model (CAPM). The CAPM formula is:

Ra = Rf + Beta * (Rm - Rf)

Where:

• Ra is the required return on equity for Decker's
• Rf is the risk-free rate of return
• Beta is the beta of Decker's
• Rm is the market risk premium

Plugging in the given values:

Rf = 3.1%

Beta of Decker's = 1.62

Rm = 7.6%

We can calculate:

Ra = 3.1% + 1.62 * (7.6% - 3.1%)

Ra = 3.1% + 1.62 * 4.5%

Ra = 11.775%

Therefore, Decker's should use a discount rate of 11.775% for the project involving manufacturing furniture.