3. You work for Selectronics, a national chain of electronics stores. Traditionally, the firm has focused on retailing a

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3 You Work For Selectronics A National Chain Of Electronics Stores Traditionally The Firm Has Focused On Retailing A 1 (94.54 KiB) Viewed 34 times

3. You work for Selectronics, a national chain of electronics stores. Traditionally, the firm has focused on retailing and most of its revenues have come directly from consumer sales. However, in recent years, Selectronics has begun to offer financing to customers. This part of the business has become a more important source of profits. The CEO has asked you to analyze an expansion of its credit business. You estimate that a major expansion of the credit business would require an initial outlay $25 million. In subsequent years, Selectronics will need to invest an additional $2 million as the business expands, increasing 5% annually. Cash profits (after tax, not including new investment) are forecast to be $3 million in the first year, growing 5% annually. Selectronics uses a discount rate of 12% to analyze new stores. You wonder if the company should use the same discount rate for the credit business. To help answer this question, you have collected stock return data for Selectronics and its major competitors. You have also collected return data for a group of finance companies that are similar to Selectronics' credit business. The spreadsheet Selectronics.xls on SloanSpace contains the data. You may assume that the riskfree rate is 5% and the market risk premium is 6%. a. According to the CAPM, what discount rate should Selectronics use to analyze the project? b. What is the value of the project using the discount rate estimated in part (a)? Should Selectronics proceed with the project? c. Using the CAPM, how does the value of the project change if the market risk premium decreases to 4%?