A company based in the U.S is evaluating a project in Mexico. The U.S. risk-free

Question

A company based in the U.S is evaluating a project in Mexico. The U.S. risk-free rate of return is 4% and equity risk premium is 6%. The project has a beta of 1.5. The yield on 10-year Mexican government bonds denominated in U.S. dollars is 13% and the comparable 10-year U.S. Treasury bond yield is 8%. The annualized standard deviation of the Mexican stock index is 36% and the annualized standard deviation of the U.S. dollar denominated Mexican government bond market is 20%. What is the country risk premium for Mexico and what is the cost of equity for the project?

Explanation / Answer

First calculate the country risk premium: Country Equity premium= Sovereign Yield Spread x [annualized standard deviation of equity index/ annualized standard deviation of the sovereign bond market currency] = [0.13 – 0.8] x [0.36/0.20] = 9.0% Next calculate the cost of equity: rCE = rF + ßCS[Market Risk Premium + Country Spread] = 0.04 + 1.5(0.06 + 0.09) = 26.5%

Related Questions

Navigate

• Browse (All)
• Browse A
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.