Grupo Real Corporation Finance

1.0 Introduction

As a hotel, under the leverage situation, there are two risks for it: business risk and financial risk; under the unleverage situation, the financial risk can be considered as zero. In the real word, the unleverage situation can not exist, Based on this case, the debt values for the project were intended to be nearly 60% of total assets, so, the Comfort Inn Hotel Santa Ana should be under the leverage situation, the business risk and financial risk should be considered, because of the debt/leverage, the discount rate need to be adjusted to incorporated the financial risk.

Company Group of a practical need to decide whether to continue the discount rate to invest in Comfort Inn in Santa Ann's resolution, the task is to explain and calculate the discount rate using CAPM model

2.0 Company Profile

Grupo Real was a subsidiary of Grupo Poma, an investment consortium participating in several different business sectors. The hotels operated by Grupo Real were located all over Central America, with a presence in Mexico and Miami, too. With the development of Grupo Real, it became an international hotel chain, by mid 2001; Grupo Real want to expand the chain's presence in the regionn, Comfort Inn Hotel Santa Ana is a target project for Grupo Real which located in Santa Ana, a town near Costa Rica's Capital city, San Jose. An appropriate discount rate should be recommended to Grupo Real for estimating the Comfort Inn Hotel Santa Ana.

3.0 Discount rate

The interest rate used in determining the present value of future cash flows, Discount rate need to incorporate all the possible risk, e.g. opportunity cost. Businesses need to consider the discount rate when deciding whether to spend some of their profits on investing, or whether to give the profit back to their shareholders.

Objective here is to identify the appropriate discount rate taking into consideration risk premiums, risk-free rates, and betas, both for related industries and for countries where the group would invest. To do this, we have three alternatives, which are the traditional method, which the group used to carry out cost of capital calculations; the second based on discount rates found by the team in the publication of a United States consulting firm; and the third was an attempt to apply the CAPM model.

Lessard had stated that to apply the CAPM in other countries, a project beta in that country had to be used. To find the beta for the project abroad, the project beta had to be adjusted by using the beta for the appropriate country. Damodaran meanwhile said the right way to include the country risk in the CAPM formula was by adding the country-risk premium to the market-risk premium, and they multiply the result by the beta of the similar project carried out in the United States. The task before Morales now was to decide what the discount rate to use should be. From my observation so far, I find that Lessard emphasized more on country-specific betas, while Damodaran emphasized on project-specific betas.

4.0 Capital Asset Pricing Model (CAPM)

A model that describes the relationship between risk and expected return and that is used in the pricing of risky securities.

The general idea behind CAPM is that investors need to be compensated in two ways: time value of money and risk. The time value of money is represented by the risk-free (rf) rate in the formula and compensates the investors for placing money in any investment over a period of time. The other half of the formula represents risk and calculates the amount of compensation the investor