Damodaran on Valuation_ Security Analysis for Investment and Corporate Finance ( PDFDrive )

(Hop HipldF0AV) #1

Thedisadvantageofthisapproachisthatittarsallcompanies
inacountrywiththesamebrushandassumesthattheyareall
exposed to country risk in the same magnitude.


Thesecondapproachisalittlemorereasonable,insofarasit
scales country risk to beta by computing cost of equity as:


Totheextentthatbetathatmeasuresexposuretoallotherrisk
also measuresexposure to country risk,this approach will
workreasonablywell.However,ifcountryriskexposure is
different from other macroeconomic risk exposure, the
approach will fail.


Thethirdandmostgeneralapproachtreatscountryriskasa
separateriskcomponentandestimatesriskexposureto that
componentseparatelyfrom beta.Ifwedefinea company’s
exposureto countryrisktobeλ,thecostofequitycanbe
written as:


Thisapproachhastwosignificantadvantages.First,itallows
fortherealitythattherearesignificantdifferencesincountry
riskexposuresacrosscompanies;export-orientedcompanies
inanemergingmarketmaybelessexposedtocountryrisk
thandomestic companies.Second, itallows usto notonly
incorporatecountryriskintothecostsofequityofdeveloped
market companies but to also consider risk exposures in
multiple countries. The third approach does require an
estimateofλ,andtherearethreewaystoobtainthevalue.

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