Bay Area Manufacturing Co. is a San Francisco based firm that has operations in the United States and is considering an investment in Changsha, China. Hunan Renmin Bank has agreed to a RMB 16,000,000 loan at a rate of 8.35%. The rest of the financing for the factory will come in the form of an equity investment from the firm (RMB 24,000,000). The total investment is RMB 40,000,000. The CFO for Bay Area has determined that DanHan Manufacturing Co., headquartered in Nanchang, China is a good proxy company to help determine the cost of capital for Bay Area’s investment in China. The CFO has made the following market estimations. Variance of DanHan’s stock = 0.810 Standard deviation of the DanHan’s stock = 0.900 Variance of the Chinese stock market = 0.423 Standard deviation of the Chinese stock market = 0.650 Variance of the US stock market = 0.160 Standard deviation of the US stock market = 0.400 Correlation of DanHan and the Chinese stock market = 0.82 Correlation of DanHan and the US stock market = 0.45 Estimated Market risk premium on the US stock market = .055 Estimated Market risk premium on the Chinese stock market = .090 Rate on government securities (T-bills) in the US = .0375 Rate on government securities in China = .0695 The spot rate is USD 0.1639 = RMB1. The tax rate for Bay Area is 39%. Inflation is expected to be 6.5% in China and 3.2% in the United States. What is the appropriate discount rate for the project?

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