The NuPress Valet Co. has an improved version of its hotel stand. The investment cost is expected to be $72 million and will return $13.5 million for 5 years in net cash flows. The ratio of debt to equity is 1 to 1. The cost of equity is 13%, the cost of debt is 9%, and the tax rate is 34%. The appropriate discount rate, assuming average risk, is:

B) 9.47%

Explanation:

debt to equity ratio = 1

equity cost = 0.13

debt cost = 0.09

tax rate = 0.34

first we must calculate the debt to value and equity to value ratios:

debt to value = debt / (debt + equity) = 1 / (1 + 1) = 1 / 2 = 0.5

equity to value = equity / (debt + equity) = 1 / (1 + 1) = 1 / 2 = 0.5

the discount rate should be:

discount rate = (equity to value ratio x cost of equity) + [debt to value ratio x cost of debt x (1 - tax rate) ] = (0.5 x 0.13) + [0.5 x 0.09 x (1 - 0.34) ]

= 0.065 + 0.0297 = 0.0947 or 9.47%