ABC Inc. is a multinational firm contemplating an acquisition in Argentina. The CFO of the company Mike Hoffman was comfortable in adding an arbitrary 5% risk premium on all its emerging market investments on top of ABC Inc.s cost of capital. However, in a recent CFO roundtable he participated, he found out that some of his peers used systematic approaches in determining country specific risk premiums. He was shocked when he saw some examples that dramatically differed from each other. For instance, in an example provided by one of his colleagues required rate of return on Brazil and Mexico in the same industry was 7% apart. In contrast, in his method, required rate of return in both countries would be almost identical. Hoffman thought Argentina project would be a good test case to see how bad 5% would look as compared to a more informed and systematically determined risk premium. Hoffman reached out to his notebook in the bookshelf to review notes he took when he read some papers his colleagues suggested. After reviewing his notes, Hoffman called his assistant and asked to gather data that he would need to estimate the required rate of return on ABCs new investment in Argentina. ABC Inc.s before tax USD cost of debt 6% 10 Year US T-Note Yield 3% Historical US EMRP 5% Historical GEMRP 4.5% Project cash flow sensitivity to Peso-Dollar 1.3 Currency Risk Premium for Peso-Dollar 1.5% Argentinean Sovereign Spread 2.5% Project Beta wrt to S&P500 Index 1.4 Project Beta wrt to MSCI-World Index 1.2 Global Market Volatility 12% Argentina Market Volatility 30% Argentine Market Correlation to S&P500 0.6 Volatility of S&500 Index 15% Argentine Market Correlation to MSCI 0.4 Capital Structure 40/60 ABC Inc.s marginal corporate tax rate 35% ABC Inc.s average cost of debt is 6% percent before taxes and companys target debt ratio is 40%. a. Estimate required rate of return ABC Inc. investors would expect from ABCs US Investments by using Shramm-Wang GCAPM Model with exchange rate risk adjustment, Bank of America Model and Lessards offshore beta model. Please note that ABC creditors also require additional risk premium compatible with country risk ABC project is exposed to. b. Estimate required rate of return if the target asset were in an emerging market economy? Use Hoffmans +5% ad hoc rule. d. Comment on the differences between the ad hoc rule and the required rate of return determined by systematic adjustments. Should Hoffman stick with its simple rule or consider adopting more informed and sophisticated models?