Piedmont Hotels is an all-equity company. Its stock has a beta of 1.15. The market risk premium is 6.5 percent and the risk-free rate is 2.3 percent. The company is considering a project that it considers riskier than its current operations so it wants to apply an adjustment of 1.5 percent to the project's discount rate. What should the firm set as the required rate of return for the project?

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24 September, 09:42

Piedmont Hotels is an all-equity company. Its stock has a beta of 1.15. The market risk premium is 6.5 percent and the risk-free rate is 2.3 percent. The company is considering a project that it considers riskier than its current operations so it wants to apply an adjustment of 1.5 percent to the project's discount rate. What should the firm set as the required rate of return for the project?

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Bryce Smith · Answer 1

Risk-free rate (Rf) = 2.3%

Beta (β) = 1.15

Market risk premium = 6.5%

ER = Rf + β (Market risk-premium)

ER = 2.3 + 1.15 (6.5)

ER = 2.3 + 7.475

ER = 9.775%

The required rate of return for the project

= 9.775 + 1.5

= 11.275%

Explanation:

In this case, we need to calculate the expected return based on capital asset pricing model. Then, we will add the risk-adjustment of 1.5% to the expected return obtained from capital asset pricing model.