Question

Piedmont Hotels is an all-equity company. Its stock has a beta of .94. The market risk premium is 7.5 percent and the risk-free rate is 3.3 percent. The company is considering a project that it considers riskier than its current operations so it wants to apply an adjustment of 2.5 percent to the project's discount rate. What should the firm set as the required rate of return for the project

Answer 1

Required rate of return for the project = 9.7%

Step-by-step explanation:

The risk-adjusted discount factor = cost of equity + the adjustment

Cost of equity can be calculated using the capital asset pricing model CAPM

Using the CAPM , the rate of return on equity can be determined as follows:

E(r)= Rf +β(Rm-Rf)

E(r) =? , Rf- 3.3%, Rm- 7.5%, β- 0.94

Cost of equity = Rf + β (Rm -Rf)

Cost of equity = 3.3% + 0.94×(7.5-3.3)= 7.248

The risk-adjusted discount factor= 7.248 + 2.5= 9.748

Required rate of return for the project = 9.7%