You are considering entering the automobile industry. To make this decision, you

Question

You are considering entering the automobile industry. To make this decision, you need to know the appropriate discount rate to use in calculating the net present value of the investment. Suppose the risk-free interest rate is 4.5 percent and the stock market's expected return is 13.00 percent. Also suppose that if the stock market's value rises by 1 percent, the stock value for a producer of automobiles typically rises by 0.5 percent. First, what is the asset beta for producers of automobiles in this example? Beta is_____. (Enter a numeric response rounded to two decimal places.) In turn, the discount rate that you should use is R= _____ percent.

Explanation / Answer

Since a increase of 1% in market , increases the return of automobile stock by 0.5%, beta = 0.5. Beta determines the relation between the return of stock market and the individual asset

Automobile Discount Rate = Risk Free Rate + Beta *( Market Return - Risk free rate)

= 4.5% + 0.5 *( 13% - 4.5%) = 4.5% + 4.25% = 8.75%

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