Name: Nova E.

Hinoyog Year and Section: BSBA – 3D Date: February 9, 2022

Instruction. Submit your answers through Google Classroom or FB Messenger. Show your complete solution.

Part I. What I know chart (20 pts)

What I know Questions What I learned

It is the value of as time passes by.
It is the unsure state of a business.
I don’t have any idea of what risk
premiums are.
What is time value of money?
What is business uncertainty?
What are risk premiums? Briefly
discuss.
The present value and future value of
money
According to embroker.com Business
uncertainty refers to situations in
which businesses face risks that
can't be foreseen or measured.
During these times, it may be hard
for businesses to predict their
performance due to unprecedented
or constantly changing events.
An investment that can be sold
quickly is less risky than an
investment that cannot be sold as
quickly at fair market value. For the
harder-to-sell assets, called illiquid
assets, an investor will expect a
higher return to compensate for the
risk of not being able to quickly turn
that asset into cash.

Part II. Problem-solving

1. Assuming you are the newly hired corporate financial analyst of a Chinese Company and your main job is
to analyze the net value of its 15-year project. You need to work out the correct discount which is based on
the weighted average cost of capital. The cash flows are in real terms, the nominal risk-free rate for the 15-
year government bonds rate is 2.7% and inflation rate is 0.9%. With such information, you are required to
work-out the risk-free rate that you must use if the market return in Korea is 5% and finally calculate the cost
of equity component assuming a beta of 1.2. (40 pts)

Required: RFRR, Cost of Equity

1+ Nominal Risk Free Rate

Real Free Risk Rate =
1+ Inflation Rate

RFRR = (1+2.7) / (1+0.9)

= 3.7% / 1.9%

= 1.94 %

Cost of Equity = Risk-Free Rate of Return + Beta * (Market Rate of Return – Risk-free Rate of Return)

= rf + Equity Risk Premium

= rf + Beta × Market Risk Premiu

= rf + Beta × (rm − rf)

= 1.94% + 1.2 × (5% − 1.94%)

= 5%

2. Assume that the RFRR is 10% more than the RRFR in Problem 1, you are tasked to calculate the cost of
equity with an estimated equity risk premium of 5.75%. (20 pts)

Required: Cost of Equity

Cost of Equity = Risk-Free Rate of Return + Beta * (Market Rate of Return – Risk-free Rate of Return)

= rf + Equity Risk Premium

= rf + Beta × Market Risk Premiu

= rf + Beta × (rm − rf)

= 5.75% + 1.2 × (10% − 5.75%)

= 10%

3. Solve for the cost of equity assuming your RRFR is similar with problem 2 and your equity risk premium is
2.65%. (20 pts)

Cost of Equity = Risk-Free Rate of Return + Beta * (Market Rate of Return – Risk-free Rate of Return)

= rf + Equity Risk Premium

= rf + Beta × Market Risk Premiu

= rf + Beta × (rm − rf)

= 2.65% + 1.2 × (10% − 2.65%)

= 11%