A NOTE ON CROSS BORDER VALUATION
FINC 580 – Ken Shah
There are two different approaches which, in theory, would give the same value:
Approach A: Convert foreign currency cash flows to local currency ($) using
expected future (forward) exchange rate. Discount at local ($) WACC. This
approach assumes Interest Rate Parity holds. There should be an adjustment
for political risk.
Approach B: Foreign currency CF discounted at foreign WACC. This is as if
you are doing a normal valuation in a foreign country. Arrive at value in foreign
currency, and then use spot exchange rate to get US $ value. Does not assume
IRP, and no explicit adjustment for political risk.
Most multinationals use Approach A for valuing investments in emerging
countries. This requires the estimation of US $ required rates of return for a
foreign project/company.
Estimating US $ required rates of return (Re) of a foreign project/firm:
There are two approaches:
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Global single factor CAPM
Segmented Markets CAPM
Global single factor CAPM: Assumes high degree of capital market integration
between a local equity market and global equity market. If capital markets are
assumed to be integrated globally, then estimation of a (foreign) firm’s beta is
done using the global market index. The political risk of a particular country in a
globally diversified market portfolio is an unsystematic risk, and is diversified
away. Hence, there is no explicit adjustment for political risk of the foreign
country in this approach.
Re = Rf local +(BetaFirm Global x EMRPGlobal)


Rf is based on local (US) government bonds
Beta and EMRP is estimated using a global market index
Note: You still need to unlever/relever beta to reflect the intended capital
structure (D/E) ratio. Use local tax rate. Also, in WACC, use local tax rate. Cost
of debt is in local currency.
This approach is simpler to implement.
Segmented Markets Approach: Assumes that equity markets are not integrated,
especially between developed and emerging countries. Modifies the CAPM as
used for local (US) market for two additional effects: political risk (π), and country
equity market volatility (BetaCountry).
Re = Rf + π + (BetaCountry x BetaFirm) x (EMRP)

Rf and EMRP are in local currency ($)

BetaFirm is beta for similar companies in local (US) market – again
unlever/relever to reflect the proper capital structure (D/E).
Political risk premium (π): This adjustment is necessary because using
local inputs assumes political risk in the local country, not foreign country.
One measure is the yield spreads between foreign and local government
bonds.

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Country equity market volatility (BetaCountry): This is based on the idea
that:
Beta Foreign = Beta Local x Beta Foreign Equities vs. US Equities
Beta Foreign Equities vs. US Equities is also called the ‘country beta’ – and is the
measure of correlation between local and foreign equity markets:
Beta Foreign Equities vs. US Equities = Covariance (Foreign, Local) / Variance
(local)
Beta Local is beta of similar firms in the local country
In this approach, the cost of debt in WACC should be what the foreign company
could borrow in local currency (US $).
The tax rate applied in this approach is the foreign tax rate, not local tax rate.
Summary of Approaches:
Valuing Foreign Investment
Approach A
Convert foreign CF to
local currency CF using
forward rates. Discount at
local WACC. Gives value
in local currency.
Approach B
Foreign CF discounted at
foreign WACC. Convert
value to local currency
using spot exchange rate
Re using Global
Single Factor CAPM
Re using Segmented
Market CAPM
$ WACC
$ WACC
Valuing Foreign Investment