Working Paper: NBER ID: w10115
Authors: Gordon M. Bodnar; Bernard Dumas; Richard C. Marston
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.
Keywords: cost of equity capital; international acquisitions; CAPM; risk factors
JEL Codes: G3; F3
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| systematic risk associated with the investment (G11) | discount rate for equity-financed projects (H43) |
| market integration (F02) | evaluation process for acquisitions (C52) |
| political risk (P26) | discount rate (E43) |