Cost of equity using World market return: If the cost of equity is calculated using the world market return, then the key assumption made is that the libor rate of one month of2013 is used as therisk-free rate of return and the cost of equity is 1.85%. This is quite low for the company as the global market index is the market return of the two countries namely USA and Peru whereas the equity risk of the company is high. See Exhibit No 1(Bragg, 2016)
Reasons for such workings:The reason behind the beta estimation is that the libor rate is used in place of the world beta because there is no such thing as world beta equity as different companies in the world have different level of risk attached so, it is assumed that the world beta is the libor rate and the calculation is done with company’s home country risk market return and the risk free rate of return.
The betas of the specific markets are used in the calculation of the cost of equity of aparticular country in which the company operates.
The WACC of the company is used comparatively to calculate the cost of the capital company uses. The cost of equity of the world market is used in the calculation of WACC of the world market and the cost of equity of specific markets is used in the calculation of the cost of capital of that country in which the company operates. In the calculation of the WACC, the cost of equity of only Peru is taken in the calculation and the WACC is the cost of debt and the cost of equity of Peru.
The beta asset of the industry is calculated by taking the beta equity of the world and using it to calculate the world’s beta asset and the same method is used to calculate the beta asset of the industry of two countries in which the company operates.
The data are used because the libor rate is more appropriate to be used as the risk-free rate of the world and as the world beta used is of one-monthi.e. March so the libor rate of 1 month is used in order to match the calculation and the calculation should look sensible. The WACC will be of one month of the cost of capital of thecompany. The market return of the world is assumed to be the global return of the companies.
In the calculation of the free cash flow, the working capital is always taken as an incremental effect and an incremental working capital whereas the tax rate is calculated by dividing the tax rate in the income statement by the net profit of that particular period. The gearing of the company is calculated by taking non-current liabilities and dividing it by stockholder’s equity and a number oftotal liabilities. This is the formula as (debt/debt+equity)
The asset beta of industry shows the industry-specific risk which is anunsystematic risk if it is high then diversification can be done in order to combat unsystematic risk. The beta asset of the company is 0.50 in Peru whereas it is 0.52 in America and worldwide the beta asset of the company is 0.6. See Exhibit No 2…………..
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