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I would personally use both her first and her last name, and do the same for everyone else in the raffle. While not bigoted per se, refusing to treat all entrants the same is a problem in the workplace. That her name resembles an offensive word in English should not be a serious consideration in any case, as (hopefully) persons in your business (be they employees or visitors) should be mature enough to not assume it's an attempt to offend them. Besides, how hard is it to answer people who question it with "The room was named after the winner of a raffle, just like all the others."?

As Joe pointed out in the comments, adding a photo of the winner would go a long way to clearing up any misunderstandings.

Here's a simple solution (for you): pass the buck.

You can just follow through on the original plan of the promotion and name the conference room after her. I'd expect management to object to the name for the same reasons you gave, and now it's their problem to appease the employee.

And if they don't, then maybe you were wrong in thinking that most people would find it objectionable. Either way, it's not your problem any more.

It's too late now, but you probably could have avoided the problem with a "subject to management approval" condition in the contest rules.

Another possibility is to arrange a meeting with the aggrieved employee and both your managers, and try to work out a compromise. Try to explain to her that you're trying to be practical, not racist. It's unfortunate that her name sounds like a derogatory term in your language.

I'm not sure there's any way to get out of this completely cleanly. You seem to have gotten yourself into a no-win situation. Either you're going to upset this employee or put the company in a very difficult situation. Your intentions were good, but you're the victim of unintended consequences. The best you can do now is try to minimize the damage. Unfortunately, I think the employee's feelings may have to take a back seat to other employees and the company's reputation with customers (but this really needs to be a management decision).

It's surprising to me that she hasn't run into problems due to her name numerous times before. But maybe she has, and she's trying to use this opportunity to make a social statement (I wonder if she bought lots of lottery tickets to increase the chance of this). This needs to be dealt with by management, you're not responsible for how everyone else will react.

How can I defuse this situation without seeming insensitive or
intolerant? What am I doing wrong?

Unless you are willing to follow through on the terms of your fundraiser, you're going to have a very difficult time appearing sensitive and tolerant. Not having support from HR and management makes that outcome unlikely.

If you are truly correct about how your "elderly" clients would react, your best bet is to apologize profusely, cancel the "exciting fundraiser" give back all the money, and go with a more boring, generic name set. And now you know why boring, generic names are used.

Next time, think things through beforehand. If the end result was using a last name you should have looked at the last names in your company and thought "Now, what is the worst that could happen here?"

From the direction from the raffle winner (who paid to compete), your colleagues and your boss, then you have to name the room after the winner, regardless of their last name.

Your concern regarding customer perception is important, but it's a possible problem rather than a current, actual problem. I would be prepared to explain to customers why the room is named as it is if they complain, but otherwise take no action.

I would approach the raffle winner and apologise for the offence caused, while clarifying that this was not the intention. Then tell her that, to make amends for the incident, you are going to allow her to name the office suite as she likes, including offering the name that you rejected, and that you will be refunding the price of the raffle in her case. Do. This. In. Writing. This gives you an out if the chosen name does actually offend. And it also counts as written evidence of your original intention and that you tried to make amends for the misunderstanding.

A few questions:

1) Who are these people saying you're a racist? Are they below or above you in seniority? Are they numerous or a small group? If there is a group of low-level employees causing this ruckus, then I would just go to management and tell them the story you have told here: "I did this thing, it kind of backfired, now there is a problem" and have management discuss the issue directly with the person in question and work it out. Take yourself out of the equation completely and let management take the fall.

2) If you try the above and it fails (management refuses to back you up), then imo it's an issue of company culture. If management fails to back you up despite you obviously trying to provide value to the business, then obviously the value you are providing is not strong enough for management to care. In which case, I would just cave and name the room after the employee as originally planned. The business consideration that naming a room after a swear word is (in this case) obviously of higher value to management than appearing professional is, and management will take the hit, not you, in the end, with fewer client contracts and less income and so on. In this case, however, I would document everything you have done and continue to do in case it blows back in your face later.

3) If you are management or HR, then you have a stronger position. Your position is to protect the business and maximize the needs of your clients, including having a presentable and professional business environment for them to visit. Put your foot down: "No, we will not have swear words on our conference rooms, sorry, end of discussion, if you would like to submit your resignation because you believe I am a racist due to protecting business interests then feel free to do so effective immediately". IANAL but I can't believe any court of law would find you liable under discrimination laws for failing to put a swear word on the door of a conference room in your office space under the "reasonable person" standard.

In any of the above 3 cases, I would offer to refund the money of this person though; she paid for the honour of having the room named after her, she should either get what she paid for or get her money returned. It's not fair to keep her money. If the money has already been donated, then the money might have to come out of your own pocket personally.

One alternative you might want to suggest is to name the conference room using the full name of the person. That way at least it might kind of look like the room isn't just named after a swear word, and in fact named after a particular person. Another option (credit to @JoeStrazzere in a comment thread on a different answer) is to put pictures of all the raffle winners in the rooms, along with their full names.