Question

1. Decker's is an all-equity financed chain of retail furniture stores. Furniture Fashions, afurniture maker, is the primary supplier to Decker's. Decker's has a beta of 1.54 ascompared to Furniture Fashion's beta of 1.37. The risk-free rate of return is 2.6 percentand the market risk premium is 7.9 percent. What discount rate should Decker's use if itconsiders a project that involves the manufacturing of furniture?

   		14.54 percent
   		12.92 percent
   		13.50 percent
   		13.42 percent
   		14.08 percent

Answer 1

The discount rate refers to the rate of return expected by the company from any project. It is the rate of return that a company can earn on any other project.

Discount rate that Decker's should use should if it considers a project that involves the manufacturing of furniture should be related to the Beta of Furniture Fashion's beta because it is the supplier of furniture to Decker.

Risk-free rate of return = 2.60%

Beta of Furniture fashion = 1.37

Market risk premium = 7.90%

Discount Rate that Decker's should use is as follows:

= risk-free rate of return + (beta of Furniture fashion * market risk premium)

= 2.60% + ( 1.37 * 7.90% )

= 2.60% + 10.823%

= 13.42%

So, the Discount rate that Decker's should use is 13.42% and the correct answer is option (d)

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