Cost of Capital Estimation in Emerging Markets

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
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