EMERGING MARKET COST OF CAPITAL Case Solution
Cost of Equity (Market return of Global Market)
Moreover, cost of equity for global market return was calculated by the CAPM model. The average market return was taken 2.534%, the risk-free rate of the Global index was 0.601% which was extracted by taking the 9 months’ average of global LIBOR rate. Afterwards, it was multiplied by the world’s equity beta of 0.77 which resulted in the cost of equity of 2.09%.
Cost of capital Nextel Peru
To calculate the cost of capital of Nextel Peru, first I find country risk premium under following formula
ST dev on stocks in Peru is 9% and St dev on debt in Peru is 27.35%, after putting number in the above formula, I got the 0.65% country market risk premium.
After calculating US market risk premium, I must find US cost of capital, For that I use the formula
US MRP is 5% mentioned in the case, country MRP is 0.65% and Beta, mentioned in the case is 0.65, In the case NII holdings’ beta is mentioned so I have taken the same beta for Beta of Nextel Peru. Risk free rate of US 3.09%, after putting the numbers in formula, I got 6.7% as US cost of capital.
Now to find Nextel Peru Cost of capital, I use the formula
Risk free rate of Peru is 5.06%, risk free rate of US is 3.09%, US cost of capital is 6.7% and I get an estimated 8.7% as Nextel Peru cost of capital. (See Exhibit 3)
NPV of Nextel Peru
To find the NPV, I use the formula
FCF margin respect to the operating revenue is 4.6% and Growth rate is 5%, as in the fourth quarter of Nextel Peru growth rate is 5%. FCF0 is 15731 and FCF1 is 16659 and finally I get the NPV of $580 million. (See Exhibit 5)
Estimated Asset beta
After finding the cost of equity, it was necessary to calculate the asset beta of the company for evaluating the unsystematic risk which can be diversified by controlling the asset beta of the company or taking the asset beta, which is the lowest. Asset beta calculates the risk exposure of the company with respect to the market risk or unsystematic risk. The beta asset for Nextel Peru is calculated as 0.4812. It is calculated as 0.4961 for the US market and it is 0.57432 for Global market return. This shows the company’s stock is less volatile if we take into consideration the beta asset with Nextel Peru return. (Vance Lessing, 2005)
By looking at the above factors, we can conclude that the NII Holdings is losing its market share and revenues due to tough competition in the market which results in the inefficiency and ineffectiveness of the company. The company is not able to sustain its profits and has incurred losses of $765 million in the year 2012.(Nick French, 2005).
Company’s cost of capital is 8.7% and NPV is $580 million so as NPV is greater than purchase price, NII holdings should not accept the price.
Currently, the company’s structure is focusing more on debt financing which needs to be managed. The company is generating 75% of its financing from debt and only 25% from equity.
It is recommended to the NII holdings to analyze the market conditions which need to be controlled by taking corrective measures and using the appropriate strategies of price cuts and attracting more customers. It should evaluate its cost of capital by taking the data from Nextel Peru and the valuation of the company needs to be done by using the Net present value. NPV is $580 million, So, it is recommended not to accept the purchase price of $400 million as the company has more growth opportunities and global presence…………
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