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Valuation: International WACC & Country Risk – Part 1

Valuation: International WACC & Country Risk – Part 1


From June until August 2019 I have written 6 blogs on business valuation (e.g. topics: Multiples, DCF, LBO analysis, M&A analysis) and financial modelling in order to calculate enterprise value. These blogs are still available, you can find the links of the blogs at the very end of this blog.


In the upcoming months, I will write several blogs on the so called “Cost of Capital” that is used in business valuation.


I got inspired to do this after reading the book: “The real cost of capital: A business field guide to better financial decisions” (2004). The book is written by Tim Ogier & John Rugman & Lucinda Spicer. I really recommend any Corporate Finance professional to read this book, since it is so practical and well-grounded in theory!


Blogs in this sequence that I have published already (with the links);


Article 1: Valuation & Betas (CAPM)


Article 2: Valuation & Equity Market Risk Premium (CAPM)


Article 3: Is the Capital Asset Pricing Model dead ? (CAPM)


Article 4: Valuation & the cost of debt (WACC)


Article 5: Valuation & Capital Structure (WACC)

In this sixth one in the sequence I will talk about the “International WACC” and “country risk”.


Consultant & Trainer: Joris Kersten


I am an independent M&A consultant and Valuator from The Netherlands.


In addition, I provide training in “Financial Modelling”, “Business Valuation” and “Mergers & Acquisitions” all over the world. This at (investment) banks, corporates and universities.


Also I provide inhouse training on request and I have two open training programs in business valuation in my home country The Netherlands.


At the very end of this blog you can find all information about my open training programs.


Introduction: Country risk


By country risk is meant the downward risks to cash flows, and more specific, the risk factors which have the potential to affect all investments in a country simultaneously.


These include political, economic, financial and institutional risks associated with a country.


It is very hard to adjust cash flows with country risks, because it is hard to estimate to what extent the risks above have an effect on cash flows.


For this reason, many practitioners add a “country risk premium” (CRP) to a CAPM based cost of capital.


The CRP for a country can be derived in a number of ways:

-Simply adding a premium of a few percentage points based on subjectivity;

-Examining the yield spreads on sovereign bonds.


In this blog the cash flows will not be adjusted for country risk factors, so then it is logical to include an “uplift” for country risk in the WACC calculations for international investments.


Although you need to be careful with adding a CRP (and where). More on this topic later on in this blog.

(Tim Ogier, John Rugman, Lucinda Spicer, 2004)


Country risk issues


The sovereign spread approach is often used to calculate the CRP as mentioned. The CRP estimated from the sovereign spread approach is a spread on debt. But the same CRP is frequently used in calculations of the cost of equity.


Let’s now first take a look at the 5 main approaches to calculate a cost of equity in international markets. And later on we will look at the “international cost of debt” and “international WACC”

-Method 1: Global CAPM model;

-Method 2: Home CAPM model;

-Method 3: Foreign CAPM model;

-Method 4: Relative volatility model;

-Method 5: Empirical analysis basis on country credit ratings.


This this blog; “Valuation: International WACC & Country Risk – Part 1”, I will discuss the cost of equity methods 1, 2 and 3.


And in part 2 of this blog (coming soon), I will discuss method 4 and 5, including the international cost of debt and international WACC.

(Tim Ogier, John Rugman, Lucinda Spicer, 2004)


Method 1: The global CAPM approach


This model measures all of the variables assuming there is a global supply and demand for all forms of capital.


The model is therefore based on a global risk free rate, a single global EMRP (equity market risk premium) and a global beta.


So it assumes that investors hold fully diversified international portfolios made up of stocks from around the world.


And it is common to implement the model in a particular currency. So for example, the US implementation of the global CAPM would be to use the US risk free rate.


And then use a “world equity index” measured in dollars in order to estimate beta.

(Tim Ogier, John Rugman, Lucinda Spicer, 2004)


Global beta


A source for a global market portfolio is the “Morgan Stanley World Capital Indices” (MSWCI).


Estimates of global betas can be sources from data provides such as Bloomberg, by using one of the MSWCIs as a benchmark index in the process to calculates betas.


Since most individual stock markets are not perfectly correlated with the world market, betas with respect to the MSWCI are often lower than betas calculated with respect to a home market.


The most likely explanation for lower global betas is that for example UK listed companies with significant parts of their business in the UK, are much more likely to be influenced by factors that affect the UK stock market, than factors that drive the global index.


Because betas are measured by correlating changes in company’s share prices in relation to stock market indices, ceteris paribus, this would lead to higher measure home betas than global betas.


The phenomenon of global betas being lower than home betas is empirically validated by “Bruno Solnick”. He demonstrated that adding international investments to a domestic portfolio usually reduced the standard deviation of portfolio returns through greater diversification.


For practitioners this would mean that in situations where a company’s shareholder register is largely dominated by investors holding fully diversified global portfolios, then there are strong arguments for using the global CAPM.

(Tim Ogier, John Rugman, Lucinda Spicer, 2004)


Global EMRP


If it would be appropriated to apply a global model, then there would be a single global EMRP, which could be calculated in any country.


But even if capital markets are integrated the EMRP may vary, because of the composition of stocks in the specific market.


For example, a specific country might have a composition of stocks that are more skewed towards low risk sectors as the utility sector. And it is reasonable to expect that these stocks will generate returns lower than of average beta stocks.


In these circumstances the EMRP will vary from country to country because of different stock compositions. So countries with a lot of high systemic risk stocks will have relative high EMRPs, and countries with lots of low systematic risk stocks will have relatively low EMRPs.


This effect is larger in emerging markets where the local market index may be dominated by a few large companies.


Now the question comes up on how to calculate the global EMRP when individual country EMRPs vary due to a specific stock composition.


A practical approach offered by the famous research institute in valuation “Ibbotson Associates” is multiplying an EMRP that has been measure for a specific market with the correlation of that market with the world index.


So this means calculating a “beta” for individual world markets with reference to the global index.

(Tim Ogier, John Rugman, Lucinda Spicer, 2004)


Global risk free rate


If it is considered appropriate to apply a global CAPM, then this implies there is a single market for capital, and hence a single global risk free interest rate.


This only complexity arises where expected different inflation levels and currency movements mean that the nominal risk free rates (nominal = including inflation, real = excluding inflation) will differ between countries.


A way to derive a global risk free rate is to calculate the real (= excluding inflation) rate of return on government bonds of a country that is considered to be of top rated credit quality. And this “real figure” (excluding inflation) can then be converted into nominal terms (including inflation) in whatever currency required.

(Tim Ogier, John Rugman, Lucinda Spicer, 2004)


Method 2: Home CAPM approach


The home CAPM approach assumes that equity markets are segmented and calculates CAPM variables with respect to the home benchmarks. With “home” is meant the country where the investor is located.


The key feature of this approach is that it involves using all the variables in relation to the home market portfolio.


So if investors would hold a globally diversified portfolio, the situation would be best approximated by a global CAPM approach.

(Tim Ogier, John Rugman, Lucinda Spicer, 2004)


Home beta


The correct measure of “systematic risk” is given by a beta measured against the home portfolio.


So when a US company is going to invest in a UK electricity utility company, then the correct beta from the perspective of “home CAPM” is the beta of “UK electric companies” calculated by performing a regression against the US market.

(Tim Ogier, John Rugman, Lucinda Spicer, 2004)




The EMRP for the home CAPM approach is estimated just as the standard CAPM approach.


But for investments in some countries, especially emerging markets, practitioners sometimes add a premium to the EMRP calculated on the home basis. This in the form of a CRP, as mentioned before.


But the question is whether taking a higher EMRP than in the home market EMRP would be appropriate ?


The home market CAPM is often adopted when the international investment is taken by an investor whose other investments are either concentrated in the home market, or only partially diversified internationally.


But evidence suggests that adding stocks from international countries to a home portfolio can actually reduce overall portfolio variability.


This undermines the case of increasing the EMRP. So maybe we better take up the CRP in the home risk free rate.

(Tim Ogier, John Rugman, Lucinda Spicer, 2004)


Home risk free rate


Concerning the risk free rate care needs to be exercised to that the “nominal rate” is used appropriate to the currency denomination of the cash flows.


And that a CRP is applied only if the cash flows have not already been adjusted for country risk.

(Tim Ogier, John Rugman, Lucinda Spicer, 2004)


Method 3: Foreign CAPM approach


It is also possible to estimate CAPM variables using foreign market information. By foreign we mean the country where the investment is located.


So an investment in India includes an Indian risk free rate, and Indian company beta (derived by regressing the company’s stock with respect to the Indian market), and an EMRP based on Indian estimates.


But the problem with this method is that often it is very difficult to find sufficient or reliable financial information on developing markets.


When it is possible to use a foreign CAPM approach we might expect a cost of equity which is slightly higher than the home CAPM approach.


This because foreign EMRPs may be higher than home EMRPs, especially when the “foreign country” is an emerging market and the “home country” an OECD country.


Remarkably, a higher foreign EMRP may look consistent with adding a CRP to the home EMRP.


And remarkably, a higher foreign EMRP may look inconsistent with that additional diversification by investors should result in a lower EMRP.


The cost of equity from the foreign CAPM is applicable to cash flows denominated in the foreign currency in nominal terms (including inflation), and they should not have been adjusted yet for country risk. This because the foreign risk free rate implicitly includes a premium for country risk.

(Tim Ogier, John Rugman, Lucinda Spicer, 2004)


Valuation: International WACC & Country Risk – Part 2


In my next blog I will continue with this topic. I will then discuss the international “cost of equity” method 4 and 5, including the international cost of debt, and the resulting international WACC.


Stay tuned !!! 🙂


And when you have any questions in the meantime do not hesitate to contact me on:


Sources used for this blog


· The real cost of capital: A business field guide to better financial decisions (2004). Prentice Hall Financial Times/ Pearson Education. Tim Ogier & John Rugman & Lucinda Spicer. 9780273688747.


This book is fantastic and very practical, just a pleasure to read for every investment professional. Highly recommended! 😊


Training Calendar on Business Valuation of Joris Kersten:


In case you like additional in class training:


In my home country The Netherlands, and abroad, I provide open training programs in “Business Valuation” and “Financial Modelling”.


The next sessions are given below:

1. Business Valuation & Deal Structuring (6 day training): 18, 19, 20, 21 and 23, 24 March 2020 @ Uden in the South of The Netherlands;

2. Financial Modelling in Excel (4 day training): 20, 21, 22, 23 April 2020 @ Uden in the South of The Netherlands;

3. Financial Modelling in Excel (5 day training): 2, 3, 4, 5, 6 February 2020 @ Riyadh in Saudi Arabia.


All info on these open training sessions can be found on:


And 130 references on my training sessions can be found on:


Trainer & Consultant: J.J.P. (Joris) Kersten, MSc BSc RAB


· 130 recommendations on his training can be found on:

· His full profile can be found on:


J.J.P. (Joris) Kersten MSc BSc RAB (1980) is owner of “Kersten Corporate Finance” in The Netherlands, under which he works as an independent consultant in Mergers & Acquisitions (M&A’s) of medium sized companies.


Joris performs business valuations, prepares pitch books, searches and selects candidate buyers and/ or sellers, organises financing for takeovers and negotiates M&A transactions in a LOI and later in a share purchase agreement (in cooperation with (tax) lawyers).


Moreover, Joris is associated to ‘AMT Training London’ for which he provides training as a trainer and assistant-trainer in Corporate Finance/ Financial Modelling at leading investment banks in New York, London and Hong Kong.


And Joris is associated to the ‘Leoron Institute Dubai’ for which he provides finance training at leading investment banks and institutions in the Arab States of the Gulf.


In addition, Joris provides lecturing in Corporate Finance & Accounting at leading Universities like: Nyenrode University Breukelen, TIAS Business School Utrecht, the Maastricht School of Management (MSM), the Luxembourg School of Business and SP Jain School of Global Management in Sydney.


Moreover, he provides lecturing at partner Universities of MSM in: Peru, Surinam and Mongolia. And at partner Universities of SP Jain in Dubai, Mumbai and Singapore.


Joris graduated in MSc Strategic Management and BSc Business Studies, both from Tilburg University. In addition, he is (cum laude) graduated as “Registered Advisor Business Acquisitions” (RAB), a 1-year study in the legal and tax aspects of M&A’s. And Joris obtained a degree in “didactic skills” (Basic Qualification Education) in order to lecture at Universities.


Currently Joris is doing the “Executive Master of Business Valuation” to obtain his title as “Registered Valuator” (RV) given out by the “Netherlands Institute for Registered Valuators” (NIRV). This title will enable Joris to give out business valuation judgements in for example court cases.


J.J.P. (Joris) Kersten, MSc BSc RAB. Email: Phone: +31 6 8364 0527


Earlier blogs on “Business valuation to Enterprise Value”


From June until August I have written the following blogs on valuation:


1) LBO Analysis:


2) M&A Analysis:


3) Discounted Cash Flow Valuation:


4) Valuation Multiples 1 – Comparable Companies Analysis:


5) Excel Shortcuts & Business Valuation:


6) Valuation Multiples 2 – Precedent Transaction Analysis:


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