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Cross-Border Valuation: The International Cost of Equity Capital

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  • Bodnar, Gordon

    (Johns Hopkins U)

  • Dumas, Bernard

    (INSEAD)

  • Marston, Richard

    (U of Pennsylvania)

Abstract

How does a firm in one country evaluate an investment in a firm in another country, or how does it evaluate a foreign project that the firm itself is undertaking? The firm must estimate future free cash flows just as in a domestic project, but choosing an appropriate discount rate is a particular challenge. This study examines the determinants of the discount rate for an international acquisition or project by examining the sources of risk in an international setting. These risks include stock-market price risk measured with various versions of the capital asset pricing model, as well as exchange rate risk and political risk. To measure stock market risk, both segmented and integrated models of the world equity markets are considered. The emphasis of the study is on some of the practical aspects of estimation, particular for markets where no comparable investments exist on which to base estimates of risk premiums. To show how each of these risks might be measured, the study reports estimates for a representative French firm, Thals. The estimates range widely depending on whether or not the equity market is globally integrated.

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Bibliographic Info

Paper provided by University of Pennsylvania, Wharton School, Weiss Center in its series Working Papers with number 03-3.

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Date of creation: Jul 2003
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Handle: RePEc:ecl:upafin:03-3

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References

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  1. Eugene F. Fama & Kenneth R. French, 2002. "The Equity Premium," Journal of Finance, American Finance Association, vol. 57(2), pages 637-659, 04.
  2. Adler, Michael & Qi, Rong, 2003. "Mexico's integration into the North American capital market," Emerging Markets Review, Elsevier, vol. 4(2), pages 91-120, June.
  3. Dumas, Bernard & Solnik, Bruno, 1995. " The World Price of Foreign Exchange Risk," Journal of Finance, American Finance Association, vol. 50(2), pages 445-79, June.
  4. Bodnar, G.M. & Dumas, B. & Marston, R.C., 1998. "Pass-Through and Exposure," Weiss Center Working Papers 98-01, Wharton School - Weiss Center for International Financial Research.
  5. William Goetzmann & Philippe Jorion, 1997. "A Century of Global Stock Markets," Yale School of Management Working Papers ysm53, Yale School of Management, revised 01 Aug 2000.
  6. Fama, Eugene F & French, Kenneth R, 1996. " Multifactor Explanations of Asset Pricing Anomalies," Journal of Finance, American Finance Association, vol. 51(1), pages 55-84, March.
  7. Brennan, Michael J. & Chordia, Tarun & Subrahmanyam, Avanidhar, 1998. "Alternative factor specifications, security characteristics, and the cross-section of expected stock returns," Journal of Financial Economics, Elsevier, vol. 49(3), pages 345-373, September.
  8. Harvey, Campbell R, 1991. " The World Price of Covariance Risk," Journal of Finance, American Finance Association, vol. 46(1), pages 111-57, March.
  9. Donald R. Lessard, 1996. "Incorporating Country Risk In The Valuation Of Offshore Projects," Journal of Applied Corporate Finance, Morgan Stanley, vol. 9(3), pages 52-63.
  10. Adler, Michael & Dumas, Bernard, 1983. " International Portfolio Choice and Corporation Finance: A Synthesis," Journal of Finance, American Finance Association, vol. 38(3), pages 925-84, June.
  11. Heston, Steven L. & Rouwenhorst, K. Geert, 1994. "Does industrial structure explain the benefits of international diversification?," Journal of Financial Economics, Elsevier, vol. 36(1), pages 3-27, August.
  12. Kenneth A. Froot & Emil Dabora, 1998. "How are Stock Prices Affected by the Location of Trade?," NBER Working Papers 6572, National Bureau of Economic Research, Inc.
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Cited by:
  1. Mazzotta, Stefano, 2008. "How important is asymmetric covariance for the risk premium of international assets?," Journal of Banking & Finance, Elsevier, vol. 32(8), pages 1636-1647, August.
  2. Forssbæck , Jens & Oxelheim, Lars, 2008. "Financial Determinants of Foreign Direct Investment," Working Paper Series 741, Research Institute of Industrial Economics.
  3. Samuel Mongrut Montalván & Didac Ramírez Sarrió, 2005. "Discount Rates in Emerging Capital Markets," Finance 0501013, EconWPA.
  4. Bruner, Robert F. & Li, Wei & Kritzman, Mark & Myrgren, Simon & Page, Sébastien, 2008. "Market integration in developed and emerging markets: Evidence from the CAPM," Emerging Markets Review, Elsevier, vol. 9(2), pages 89-103, June.
  5. Darcy Fuenzalida & Samuel Mongrut & Mauricio Nash & Juan Tapia, 2006. "Tender Offers in South America: Do they Convey Good News to the Market?," Working Papers 06-04, Departamento de Economía, Universidad del Pacífico, revised Aug 2006.
  6. David Schröder, 2005. "The Implied Equity Risk Premium - An Evaluation of Empirical Methods," Bonn Econ Discussion Papers bgse13_2005, University of Bonn, Germany.

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