WACC Calculation for a USD based investment in a Non-USD Country

CFA General
#1

Hi,

I have a question regarding the investment project that I am working on for a client and I have a very general question. The investment is located at an emerging market. The inflation differencial between the US and the local market is appx. 730 basis points (1.1 % vs 8.4%).

The discounted cash flow analysis is based on USD since the Feed in Tariff is on USD terms. Lending rate for the local currency is appx. 12% and Rf is around 8%. Local USD based rates are 3% for savings and 6.75% for lending.

Calculating the discount rate based on the USD rates and the local currency rates result in a different result. Rd is strait forward however I am confused regarding the calculation of Re. Since the USD Rf rate is much lower, the local currency Rf is much higher and the investment return and CAPEX is calculated in USD terms do you think it would be appropriate to use the inflation differential of both countries do adjust down Re that is determined based on the local interest rates. Wouldn’t this be like using a lower Rf in the CAPM approach in calculating WACC.

Thank you for your comments.

#2

You are going to borrow in the foreign currency for a project that receives revenue in USD?

#3

Hi Chad,

The calculations are based on the assumption that USD will be used in both borrowing and revenue generation.

#4

If that is the case you should definitely build the model in USD and use the US RFR, an equity risk premium and a foreign country risk premium. If it were me I would use a build up approach and not CAPM.