Reference no: EM13871646

United Kingdom's Vodafone Group needs a cost of capital estimate to eval- uate an investment in Brazil's mobile phone market. Vodafone's experience investing in mobile phone infrastructure in emerging markets suggests that the systematic risk of the investment from the perspective of a U.K. investor is about the same as the average systematic risk of the emerging market. The U.K. risk-free rate is rF£ = 3 percent. The world market risk premium is estimated to be (E[rW] - rF) = 5 percent. Calculate expected or required returns in pounds on a typical Brazilian investment based on each of the following models:

a. International CAPM: E[r] = rF + β(E[rW] - rF). Vodafone estimates β = 1.2 based on a regression of Brazilian stock market returns on world market returns.

b. Global and regional market factors: E[r] = rF + β(E[rW] - rF) + δ(E [rRegion] - E[rW]), where δ is Brazil's systematic risk relative to Latin American regional risk that is not included in the world market return. Vodafone estimates β = 1.2, δ = 1.5, and (E[rRegion] - E[rW]) = 4%.

c. Country credit risk model: E[r] = E[rW] + CR, where CR is an adjustment for credit risk in Brazil. Vodafone estimates CR = 4%.

d. Country spread model: E[r] = E[rW] + S, where S is the 1-year Brazilian government bond yield minus the 1-year Eurocurrency yield. Currently, this sovereign yield spread is S = 2%.

e. Modified country spread model: E[r] = rF + S(σBr-stocks/σBr-bonds), where σBr-stocks = 30% is the annual volatility on Brazilian stocks and σBr-bonds = 10% is the annual volatility on Brazilian bonds.