International mergers and acquisitions require international valuation inputs. Among the most difficult to ascertain is the cost of capital—the return necessary to make a particular investment worthwhile.
Also referred to as the discount rate, cost of capital is an opportunity cost calculation, estimating the rate of return that might have been earned by putting the same capital into another investment with equal risk.
Estimating cost of capital in foreign countries can be complicated—and some valuation professionals argue that in today’s global economy, risks for different countries are not as important as they once were. However, most agree that country risks do still exist, with some countries and markets not particularly integrated into world markets.
Investments in some countries are riskier than others. Generally, these risks can be categorized into political, economic, and financial factors.
Financial risks are largely centered on issues surrounding the country’s currency and exchange rates.
Economic risks include inflation, regulation, labor rules, and the foreign government’s debt situation.
Political risks include government instability, political terrorism, war, bureaucratic issues, and corruption.
Calculating cost of capital and related risks in developed countries can be relatively straightforward because there’s an abundance of data and comparable companies for valuation analysts to reference. But for emerging economies, a lack of data and potentially increased risks add difficulty.
Because of these complexities, it’s important to work with a valuation team that is knowledgeable about foreign investments and has access to global resources that can help determine the appropriate assumptions and inputs.
Remember that as a member of Allinial Global, our firm has relationships with member firms in over 140 countries. With these relationships in place, we are well positioned to serve your valuation needs for transactions here and abroad.