Thefirstistobaseitontheproportionofafirm’srevenuesin
aparticularmarket,scaledtotheaveragefirm’srevenuesin
thatmarket.Thus,acompanythatderives 35 percentofits
revenues in Brazil, where the average company gets 70
percentofitsrevenuesdomestically,wouldhavealambda(λ)
of0.5. Thesecond isto incorporateintothelambda other
aspects of a firm’s risk exposure, including where its
manufacturing facilities are and risk management products
thatituses.Thethirdistoestimatelambdamuchthewaywe
estimate beta by regressing returns on a company’s stock
against returns on a country bond (or some other
market-traded instrument that is primarily impacted by
country risk).
38
ILLUSTRATION 2.4: Cost of Equity for an Emerging
Market Company: Embraer-Early 2005
EmbraerisaBrazilianaerospacecompanythatcompeteswith
Boeing and Airbus in the commercial aircraft market. To
estimate its cost of equity, we began by estimating a
bottom-up beta for the aerospace business. Usingpublicly
tradedaerospacefirmslistedgloballyasourcomparablefirm
sample, we estimated an unlevered beta of 0.95. With
Embraer’sdebt-to-equity ratioof 18.95%and themarginal
taxrateof34%forBrazil,weestimatedaleveredbetaof1.07
for the company:
Toestimatethecompany’sdollarcostofequity,weuseda
risk-freerateof4.25%,thehistoricalriskpremiumof4.84%
fortheUnitedStatesfrom 1926 to2004,andthecountryrisk