Question

LATAM is Latin America’s biggest airline, headquartered in Chile. The company has approached you for advice on hurdle rates in its three biggest regions: Chile, Brazil, and US.

	10-yr gov’t bond rate in US $	10-yr gov’t bond rate in local currency	St. Dev. in local equity index	St. Dev. on 10-yr gov’t bond
Chile	5.9%	7.5%	30%	21%
Brazil	4.65%	10.75%	24%	16%
US	3.5%	3.5%	18%	12%

   b) Assuming the US (mature market) risk premium = 5.8%, Beta 1.0 estimate the risk-free rate and equity risk premium in Chilean peso for Chilean operations.

Answer 1

Hurdle rate is nothing but lowest rate at which project will become acceptable.

Now hurdle is expected return which is

R = Rf + B (Rm-Rf) , Rf is risk free rate, Rm is Market rate and B is beta of portfolio

Now calculating euity risk premium of each market = Market premium of mature market * std deviation of local market/std. deviation of mature market

Thus,

Rm Chile = 5.8% * 30%/21% = 8.26%

Rm Brazil = 5.8%*24%/16% = 8.7%

Rm US = 5.8%*18%/12% = 8.7%

Thus, R Chile = 5.9% + (8.26-5.8)% = 8.36%

R Ind = 4.65% + (8.7-5.8)% = 7.55%

R US = 3.5% + (8.7-5.8)% = 6.4%