What is Missing in WACC in Politically Unstable Countries?

2-WACC

In this series we highlight an innovative methodology that helps isolate and calculate an explicit Political Risk Premium – a vital input for arriving at the correct cost of capital for firms operating in politically charged countries, during and after the coronacrisis.

  • The cost of equity is generally the expected cost of equity.  It includes expected dividends and expected capital gains.  The expected cost of equity is generally measured using the Capital Asset Pricing Model (CAPM)) as: expected return = r = riskless rate + beta*[risk premium].
  • The cost of debt is expected return to bondholders.  If debt is safe and priced at par, the coupon rate is cost of debt.  Otherwise, the expected cost of debt is more elusive.
  • The weighted average cost of capital (WACC) is a weighted average of the cost of debt and equity where the weights are the relative market values of the debt and equity.  The formula for WACC is:  WACC =(1-tax rate)* kD*(D/V) + kE*(E/V) where  kD is he expected return on debt, kE is the expected return on equity, D is the market value of debt, E is the market value of the equity, and V is the market value of the debt and equity (V=D+E).
  • For  developing and politically unstable unstable countries we need to add an explicit political risk premium.

Author: Sameer_Jain

Partner. Sameer Jain is founder of FinTech ActiveAllocator.com, the world’s first portal that seamlessly integrates traditional, illiquid and alternative investments within portfolios. Prior to this he was Chief Economist & Managing Director at AR Capital. Before that he headed Investment Content & Strategy at UBS Alternative Investments. At UBS, he served as a non-voting member of the Wealth Management Research investment committee, and as a capital allocator was responsible for all illiquid investing including fund manager selection and due diligence across the platform. Prior to UBS he headed product development & investment research at Citigroup Alternative Investments that managed over $75 billion of alternative investments across hedge funds, managed futures, private equity, credit structures, infrastructure and real estate. Here he led a team that developed proprietary models for portfolio strategy and asset allocation with alternative investments, provided investment support and research to pension plans, sovereign wealth funds, endowments as well as internal clients including Citi Private Bank. Before this he was with Cambridge Alternative Investments and SunGard (System Access) where he travelled to over 80 countries for work across Europe, Asia, Middle-East and Africa. He has written over 30 academic and practitioner articles on alternative investments with thousands of downloads at SSRN, presented at over a hundred industry conferences and has coauthored a book, Active Equity Management. Mr. Jain has multiple degrees in engineering, management, public administration and policy and is a graduate of Massachusetts Institute of Technology and Harvard University. He is a recipient of the Alfred Sloan Fellowship and subsequently was a Fellow of Public Policy and Management at the Harvard Kennedy School of Government for a year. He holds Series 7 and 66 securities licenses.

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