Question

You are valuing BMW, a German automotive company, in Euros and are attempting to estimate a risk-free rate to use in the analysis. The risk-free rate that you should use is:

Select one:

A. The interest rate on a US treasury bond (3.5%)

B. The interest rate on a US $ denominated long-term bond issued by the European Central Bank (3.6%)

C. The interest rate on a Euro-denominated bond issued by BMW (8.11%)

D. The interest rate on a Euro denominated long-term bond issued by the European Central Bank (3%)

Answer 1

Since you are trying to value a German automotive company in Euro, the appropriate risk-free rate to be used in analysis would be

(d) The interest rate on a Euro denominated long-term bond issued by European Central bank.

While calculating cost of equity we use the risk free rate in the CAPM model, and while valuing companies in US we use the long term treasury bonds issued by Federal reserve, so when we are valuing a company in Europe we should use the European central bank long-term bond as treasury rates (risk free rates).

Euro denominated bond by BMW can be used bond yield plus risk premium approach but not as risk free rate. US treasury bonds would not be suitable nor would be dollar denominated bond because the valuation is in Euro.