Zona Hotels is a Latin American hotel company that derives 75% of its revenues in Brazil and 25% in Argentina and you have collected the following information on the countries: 9% US $ 10-year Local Currency bond rate 10-year bond rate Brazil 4% 8% Argentina 6.5% The risk-free rate in US dollars is 1.50% and the equity risk premium in the US (a mature market) is 5%. Estimate the risk-free for Brazil. If the equity is 1.30 times more volatile than the government bonds in emerging markets, estimate the equity risk premium for the company. If the beta for Zona is 1.20. Estimate the cost of equity for Zona in Brazilian Reais.

1. Estimate the Risk free for Brazil

we will use (CAPM) Capital Asset pricing Model for calculation of Cost of Equity capital

Ke = Cost of equity capital

Ke= Rf + (Rm - Rf)*beta

Rf= is the Risk free rate

Beta = is the measure of systematic risk

Rm = is the return rate of a market benchmark

Rm-Rf = is Risk premium

Risk premium =Rm - Rf = 5%

Rm of Brajil = 8%

Rf of Brajil as follow

5% = Rm - Rf

5% = 8% - Rf

Rf = 8% - 5%

= 3%

2. Risk Premium ( Rm - Rf) of company if Beta is 1.3 time

a) Ke of Brajil = Rf + (Rm - Rf)*Beta

= 3% + (8% - 3%)*1.3

Ke of Argentina = Rf + (Rm - Rf)*Beta

Rm - Rf =5%

9%-Rf = 5%

Rf = 9% - 5%

= 4%

Ke of Argentina = 4% + (9% - 4%)*1.3

= 4% + 6.5%

= 10.5%

b) Ke of Brajil = 3% + ( 8% - 5%)*1.3

= 3% + 3.9%

= 6.9%

Hence Ke of company is = Ke of Brajil + Ke of Argentina

= 10.5% *.75 + 6.9% *.25

= 9.6%

Calculation of Risk Premium of Company= Rm - Rf

= Rf + ( Rm - Rf )*Beta

9.6% = 1.5% + (Rm - Rf)*1.3

9.6% -1.5% = (Rm - Rf )*1.3

8.1% = (Rm - Rf )*1.3

8.1%/1.3 = Rm-Rf

Rm - Rf = 6.23%

It means Risk premium is 6.23%

3) If Beta is 1.2, then cost of capital for Brajil

Ke = Rf + (Rm- Rf)*Beta

= 1.5 + ( 8% -5% )*1.2

= 5.1%