1.Jamal Winfield is an analyst with Stolzenbach Technologies, a major computer services company based in the U.S. Stolzenbach’s management team is considering opening new stores in Mexico, and wants to estimate the cost of equity capital for Stolzenbach’s investment in Mexico. Winfield has researched bond yields in Mexico and found that the yield on a Mexican government 10-year bond is 7.7 percent. A similar maturity U.S. Treasury bond has a yield of 4.6 percent. In the most recent year, the standard deviation of Mexico's All Share Index stock index and the S& 500 index was 38 percent and 20 percent respectively. The annualized standard deviation of the Mexican dollar-denominated 10-year government bond over the last year was 26 percent. Winfield has also determined that the appropriate beta to use for the project is 1.25, and the market risk premium is 6 percent. The risk free interest rate is 4.2 percent. What is the appropriate country risk premium for Mexico and what is the cost of equity that Winfield should use in his analysis?

A)                                        4.53%   19.06%

B)                                        5.89%   17.36%

C)                                        5.89%   19.06%

D)                                        4.53%   17.36%

2.Jeffery Marian, an analyst with Arlington Machinery, is estimating a country risk premium to include in his estimate of the cost of equity for a project Arlington is starting in India. Marian has compiled the following information for his analysis: 

§       Indian 10-year government bond yield = 7.20%

§       10-year U.S. Treasury bond yield = 4.60% 

§       Annualized standard deviation of the Bombay Sensex stock index = 40%.

§       Annualized standard deviation of Indian dollar denominated 10-year government bond = 24%

§       Annualized standard deviation of the S& 500 Index = 18%. 

The estimated country risk premium for India based on Marian’s research is closest to:

A)   5.8%.

B)   2.6%.

C)   4.3%.

D)   3.7%.

3.In order to more accurately estimate the cost of equity for a company situated in a developing market, an analyst should:

A)   add a country risk premium to the market risk premium when using the capital asset pricing model (CAPM).

B)   add a country risk premium to the risk-free rate when using the capital asset pricing model.

C)   use the yield on the sovereign debt of the developing country instead of the market risk premium when using the capital asset pricing model.

D)   use the yield on the sovereign debt of the developing country instead of the risk free rate when using the capital asset pricing model.

4.Mae Kioko, an analyst with Oswald Technologies, is conducting a capital budgeting analysis on an investment the firm is considering making in Argentina. The project being considered is expected to cost $200 million, and should produce net cash flows of $50 million per year for the next seven years. Since Argentina is a developing market, Kioko believes that it is appropriate to include a country risk premium when calculating the cost of equity. Kioko has researched yields in Argentina, and has observed that Argentina’s 10-year government bond yield is 9.8 percent, compared to a 4.6 percent yield for a similar 10-year U.S. government bond. Kioko also observes that the annualized standard deviation of the Argentina Merval stock exchange is 36 percent, which is higher than both the standard deviation of the S& 500 at 18 percent, and the annualized standard deviation of Argentina’s dollar-denominated government debt at 25 percent. In addition to the country risk premium, Kioko is concerned about whether Oswald will need to issue new capital to finance the project, and the impact that it may have on the firm’s cost of capital. Kioko wants to maintain the firm’s target capital structure of 70 percent equity and 30 percent debt. Currently, Oswald has slightly more than 70 percent equity as a result of $20 million in excess retained earnings that Kioko plans to use for the project. If any new capital needs to be raised, Kioko estimates that the marginal cost of debt will increase if the firm needs more than $100 million in new equity capital. After conducting her analysis, Kioko makes the following statements to her supervisor.
 

How should Kioko’s supervisor respond to her statements?

A)                                        Agree    Disagree

B)                                        Disagree       Disagree

C)                                        Disagree       Agree

D)                                        Agree    Agree

答案和详解如下：

1.Jamal Winfield is an analyst with Stolzenbach Technologies, a major computer services company based in the U.S. Stolzenbach’s management team is considering opening new stores in Mexico, and wants to estimate the cost of equity capital for Stolzenbach’s investment in Mexico. Winfield has researched bond yields in Mexico and found that the yield on a Mexican government 10-year bond is 7.7 percent. A similar maturity U.S. Treasury bond has a yield of 4.6 percent. In the most recent year, the standard deviation of Mexico's All Share Index stock index and the S& 500 index was 38 percent and 20 percent respectively. The annualized standard deviation of the Mexican dollar-denominated 10-year government bond over the last year was 26 percent. Winfield has also determined that the appropriate beta to use for the project is 1.25, and the market risk premium is 6 percent. The risk free interest rate is 4.2 percent. What is the appropriate country risk premium for Mexico and what is the cost of equity that Winfield should use in his analysis?

Country Risk Premium for Mexico

Cost of Equity for Project

A)                                        4.53%   19.06%

B)                                        5.89%   17.36%

C)                                        5.89%   19.06%

D)                                        4.53%   17.36%

The correct answer was D)

= (0.077 – 0.046)(0.38/0.26) = 0.0453, or 4.53%

Cost of equity = R_F + β[E(R_MKT) – R_F + CRP] = 0.042 + 1.25[0.06 + 0.0453] = 0.1736 = 17.36%

2.Jeffery Marian, an analyst with Arlington Machinery, is estimating a country risk premium to include in his estimate of the cost of equity for a project Arlington is starting in India. Marian has compiled the following information for his analysis: 

§       Indian 10-year government bond yield = 7.20%

§       10-year U.S. Treasury bond yield = 4.60% 

§       Annualized standard deviation of the Bombay Sensex stock index = 40%.

§       Annualized standard deviation of Indian dollar denominated 10-year government bond = 24%

§       Annualized standard deviation of the S& 500 Index = 18%. 

The estimated country risk premium for India based on Marian’s research is closest to:

A)   5.8%.

B)   2.6%.

C)   4.3%.

D)   3.7%.

The correct answer was C)

            = (0.072 – 0.046)(0.40/0.24) = 0.043, or 4.3%.

3.In order to more accurately estimate the cost of equity for a company situated in a developing market, an analyst should:

A)   add a country risk premium to the market risk premium when using the capital asset pricing model (CAPM).

B)   add a country risk premium to the risk-free rate when using the capital asset pricing model.

C)   use the yield on the sovereign debt of the developing country instead of the market risk premium when using the capital asset pricing model.

D)   use the yield on the sovereign debt of the developing country instead of the risk free rate when using the capital asset pricing model.

The correct answer was A)

In order to reflect the increased risk when investing in a developing country, a country risk premium is added to the market risk premium when using the CAPM.

4.Mae Kioko, an analyst with Oswald Technologies, is conducting a capital budgeting analysis on an investment the firm is considering making in Argentina. The project being considered is expected to cost $200 million, and should produce net cash flows of $50 million per year for the next seven years. Since Argentina is a developing market, Kioko believes that it is appropriate to include a country risk premium when calculating the cost of equity. Kioko has researched yields in Argentina, and has observed that Argentina’s 10-year government bond yield is 9.8 percent, compared to a 4.6 percent yield for a similar 10-year U.S. government bond. Kioko also observes that the annualized standard deviation of the Argentina Merval stock exchange is 36 percent, which is higher than both the standard deviation of the S& 500 at 18 percent, and the annualized standard deviation of Argentina’s dollar-denominated government debt at 25 percent. In addition to the country risk premium, Kioko is concerned about whether Oswald will need to issue new capital to finance the project, and the impact that it may have on the firm’s cost of capital. Kioko wants to maintain the firm’s target capital structure of 70 percent equity and 30 percent debt. Currently, Oswald has slightly more than 70 percent equity as a result of $20 million in excess retained earnings that Kioko plans to use for the project. If any new capital needs to be raised, Kioko estimates that the marginal cost of debt will increase if the firm needs more than $100 million in new equity capital. After conducting her analysis, Kioko makes the following statements to her supervisor.
 

Statement 1:	The country risk premium we should add to the cost of equity to capture Argentina’s country risk is 10.40 percent.
Statement 2:	If we have to raise new capital to take on the project, we should discount the cash flows at a higher cost of capital, because the amount of capital needed exceeds our marginal cost of capital breakpoint of $150 million.

How should Kioko’s supervisor respond to her statements?

Statement 1

Statement 2

A)                                        Agree    Disagree

B)                                        Disagree       Disagree

C)                                        Disagree       Agree

D)                                        Agree    Agree

The correct answer was B)

Kioko’s first statement is incorrect and her supervisor should disagree. The country risk premium is calculated as:

CRP = Sovereign yield spread (Ann. STD of index / Ann. STD of sovereign bond market)
CRP = (0.098 – 0.046)(0.36 / 0.25) = 0.7488, or 7.49%. Note that the standard deviation of the S& 500 is extra information that is not used for the calculation.

Kioko’s second statement is incorrect and her supervisor should also disagree. Although she is correct that a higher marginal cost of capital rate should be used, she is incorrect about the value of the breakpoint. The breakpoint is calculated as:

Breakpoint = (Amount of capital where source cost changes / Proportion of capital from source)
Breakpoint = ($100 million / 0.70) = $142.86 million.