Cost of Equity. A foreign subsidiary does not have an independent cost of capital. However, in order to estimate the discount rate for a comparable host-country firm, the analyst should try to calculate a hypothetical cost of capital. As part of this process, the analyst can estimate the subsidiary’s proxy cost of equity by using the traditional equation: Define each variable in this equation and explain how the variable might be different for a proxy host country form compared to the parent MNE.
Calculating the discount rate of a venture empowers the analysts to make sound decisions. It is an undertaking that ensures that a commercial venture does not make the mistake of ignoring the risks that their operations could face in the future (Kallianiotis, 2013). Moreover, the calculation of the discount rate empowers project teams to assess the viability of a project based on a valid premise. When calculating the discount rate, the analyst assessing the project run by a subsidiary should use the currency used at the local level in the host country to express the cost of capital as well as equity. Different foreign governments use different currency denominations at the domestic level. Therefore, the analyst should ensure that only the local currency is used for this purpose.
The parent firm should use the currency denomination used at home or rather in the country hosting the headquarters. The home currency should be applied when the analyst is calculating the expected returns and risks in relation to the parent company. The risk-free rate associated with the subsidiary should only be in the form of government bonds, which come in the form of the local currency. The subsidiary’s market return manifests is highlighted using the expected return on its local market portfolio. Analysts use historical records representing recent performance to calculate the subsidiary’s market return (Bake & Riddick, 2012). Meanwhile, analysts should use the beta of the companies competing with the subsidiary to determine the latter’s beta. The analysts need to assume that the beta of the companies operating in the same industry and with nearly identical performance is likely to be similar.
Bake, H. K., & Riddick, L. A. (2012). International Finance: A Survey. Oxford: Oxford University Press.
Kallianiotis, J. N. (2013). International Financial Transactions and Exchange Rates. New York: Palgrave Macmillan.
by EssayRoyal, Dec. 8, 2019, 6:50 p.m.