Question

A company usually uses a discount factor of 11%. They are considering an investment which they think is high risk. The directors propose adding a factor of 15%. What is the rate to use for the project"

Answer 1

The rate to use for a high-risk investment is calculated by adding the company's standard discount rate to the additional risk premium proposed by the directors. In this case, it's 11% + 15%, which is 26%.

Step-by-step explanation:

A company that typically uses an 11% discount factor is considering an investment that is perceived as high risk. To account for the higher risk, the directors propose adding an additional 15% risk premium to the usual rate. To determine the rate at which to value future payments of this high-risk investment, one must add the additional risk premium to the company's usual discount rate, which involves summing the standard rate and the additional risk premium.

In this scenario, the company would add the usual 11% discount rate to the additional 15% risk premium to determine the appropriate interest rate. Therefore, the new rate to use for the high-risk project would be 11% + 15%, totaling 26%.