Project Evaluation Techniques for Entrepreneurs by Roca Florencia & Rojas Arzú Jorge

Author:Roca, Florencia & Rojas Arzú, Jorge [Roca, Florencia]
Language: eng
Format: epub
Publisher: UNKNOWN
Published: 2016-12-20T05:00:00+00:00

** Take-Away ** Consulting firms and investment banks include in practice an adjustment to CAPM when investing in emerging markets, which basically consists of adding a country risk premium.

More about CAPM

There is abundant literature with theoretical explanations of CAPM. For example you can find good material on the classic books of Corporate Finance of Brealey & Myers (2003) or Stephen Ross (2008), also short publications in academic journals, such as the popular Harvard Business Review article by David Mullins (1982). While the derivation of the SML from Markowitz theory requires rather sophisticated algebraic computations, applying the model in practice offers no difficulty. As we have seen, the CAPM formula is a straight line, so that it only requires to add, subtract and multiply. The biggest challenge when using the model is the estimation of the three required inputs, in addition to professional judgment to adapt it to the concrete reality of the business and the economy, in order to reach a reasonable and relevant estimate. That is why in this book, directed to practitioners, we have chosen to include an intuitive approach of CAPM, as well as its adaptations to be used in emerging markets (often omitted in classical texts). If you would like to obtain further information about the derivation of the model and its assumptions, a suggested reading list is included at the end of the chapter.

Example: Calculating the WACC with country risk and comparable beta

In an investment project, you probably do not count with historical data to calculate a regression beta. We will now examine an example with the comparable beta methodology. Additionally, we have also included the CAPM adjustment for emerging markets (Goldman Sachs Model) in this example. To complete the cost of capital calculation, we will also compute the WACC, as it is the rate that you will need to discount the free cash flow of the investment project.

Comparable beta

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