Practitioners typically are confronted with this situation: "I know how to value a business in my country, but this one is in Country X, a developing economy. What should I use for a discount rate?" The basic insight of capital market theory, that expected return is a function of market risk, still holds when dealing with cost of equity capital in a global environment.
Estimating a proper cost of capital in developed countries, where a relative abundance of market data and comparable companies exists, requires a high degree of expertise. Estimating cost of capital in less-developed (i.e. "emerging") countries can present an even greater challenge, primarily due to lack of data (or poor data quality) and the potential for magnified financial, economic, and political risks. A good understanding of cost of capital concepts is, therefore, essential information for executives making global investment decisions.
This article provides a brief overview of:
- The risks to consider when investing globally
- International cost of capital models
- The relative risk and reward of Europe
- Diversification and cost of capital