The cost of equity of companies subject to sovereign risk

Abstract

Subject. The article considers the issue of establishing the cost of equity capital of companies, taking into account sovereign risk. Objectives. The study aims at choosing a method to estimate the cost of equity subject to country risk and a method to determine the level of sovereign risk for domestic companies. Methods. The analysis rests on two methods for determining the cost of equity given the sovereign risk, i.e. the Damodaran’s model and the hybrid CAPM model. The approaches under consideration differ in the choice of a developed market country, specifically, the United States (according to the S&P 500 Index) and Germany (according to the DAX Index), and in the choice of a method for calculating the share of country risk attributable to the company. Results. Using the Damodaran’s model and the hybrid CAPM model, I established the cost of equity, determined the degree of country risk that falls on company, for 10 domestic companies. To estimate the cost of equity for 10 companies, I used the Damodaran’s model for companies and the hybrid CAPM model (which I adjusted). Conclusions. The larger the scale of the company, the greater the degree of sovereign risk falls on it. Accordingly, the cost of equity increases, and company value decreases. The gamma index varies depending on the volatility of stock returns. This indicator better expresses company's exposure to country risk. Comparing the results with the choice of the U.S. or German base market shows that in both models, the cost of equity based on the US market will be higher, and, accordingly, the company value will be lower.