Presentation is loading. Please wait.

Presentation is loading. Please wait.

1 ALTERNATIVE WAYS TO ESTIMATE COST OF CAPITAL I think you should be more explicit here in step two...

Similar presentations


Presentation on theme: "1 ALTERNATIVE WAYS TO ESTIMATE COST OF CAPITAL I think you should be more explicit here in step two..."— Presentation transcript:

1 1 ALTERNATIVE WAYS TO ESTIMATE COST OF CAPITAL I think you should be more explicit here in step two...

2 General Model where R f denotes risk-free rate, MRP the world market risk premium, SR specific risk of the investment, and A some additional adjustment. Four Different Models two inputs ( R f and MRP ) on the basis of worldwide markets are shared by all four models two other inputs SR and A differ across the models 1. The Lessard Approach 2. The Godfrey-Espinosa Approach 3. The Goldman Sachs Approach 4. The SalomonSmithBarney Approach Cost of Equity in Emerging Markets 2

3 The Lessard Approach measures specific risk ( SR ) as the product of a project beta ( β p ) and a country beta ( β c ): where β p and β c capture the risk of industry and country, respectively. cost of equity when investing in industry p and country c is: β p ( β c ) is estimated as the beta of the industry (country) with respect to the world market, and no further adjustment ( A is assumed to be zero) 3 SR

4 The Godfrey-Espinosa Approach Two adjustments with respect to CAPM: 1) Adjusting R f by the yield spread of a country relative to the U.S. ( YS c ) A = YS c 2) Measuring risk as 60% of the volatility of local market relative to world market ( σ c / σ w ) SR = (0.60)· ( σ c / σ W ) where σ c and σ w are the standard deviation of returns of stock market of country c and world, respectively. cost of equity when investing in industry p and country c is: this model ignores the specific nature of the project, but all that matters is the country in which the foreign company invests Cost of Equity in Emerging Markets 4

5 The Goldman Sachs Approach one adjustments with respect to Godfrey-Espinosa Approach : replacing 0.60 by one minus the observed correlation between the stock market and bond market of the country c. SR = (1– SB )· ( σ c / σ W ) where SB is the correlation between stock and bond markets. cost of equity when investing in country c is: intuition of the model SB = 0 no correlation, two sources of risk (stock and bond) SB = 1 YS c captures all relevant risk 0< SB <1 the model incorporates both risk from bond and stock markets, but not double counting sources of risk Cost of Equity in Emerging Markets 5

6 The SalomonSmithBarney Approach account for the risk of investing in Specific Industry and/or Country adjustments with respect to previous models : 1) Political risk ( 1 : between 0 and 10) 2) Risk of accessing capital markets ( 2 : between 0 and 10) 3) Financial importance of the project ( 3 : between 0 and 10) A = { ( ) / 30}· YS c intuition of the model 1 is a rough estimate of the likelihood of expropriation (e.g., oil industry) 2 is low for large firms and high for small undiversified firms 3 is low for large firms investing in relatively small projects and high for small firms investing in relatively large projects Cost of Equity in Emerging Markets 6

7 The SalomonSmithBarney Approach – continued intuition of the model worst scenario A = YS c ; the best case A = 0 For example, a large international firm investing a small proportion of its capital in an industry unlikely to be expropriated ( A = 0) A small undiversified company investing a large proportion of its capital in an industry likely to be expropriated would have to incorporate a full adjustment for political risk ( A = YS c ) quantify SR (specific risk) with the project beta, then the cost of equity when investing in industry p and country c is: this model, different from three previous ones, can allow discount rate to depend on not only specific project but also the company Cost of Equity in Emerging Markets 7


Download ppt "1 ALTERNATIVE WAYS TO ESTIMATE COST OF CAPITAL I think you should be more explicit here in step two..."

Similar presentations


Ads by Google