Handbook of Finance: Investment Management and Financial Management

Chapter 71. Hurdle Rates for Overseas Projects

THOMAS J. O'BRIEN, PhD

Professor, University of Connecticut

Abstract: Estimating risk-adjusted hurdle rates for overseas projects (or divisions or subsidiaries) is generally more difficult than for domestic ones. One difficulty can be the adjustment for political risk in emerging market countries. Other difficulties arise when adjusting foreign proxy firm risk measures for debt in foreign currencies and for differences in operational hedging policies. In addition, currency differences can create issues. To estimate a foreign project's local currency cost of capital that is consistent with the project's cost of capital from the home currency perspective, the project's systematic risk in the different currencies must be measured relative to the same market index, like a global index. And the conversion of the risk and return model across currencies can be trickier than it looks.

Keywords: overseas division, cost of capital, operating beta, global CAPM, pure play proxy method, accounting beta method, country beta method, developed markets, emerging markets, sovereign risk, political risk, unlevering, FX beta, uncovered interest rate parity, FX exposure

Financial managers often need to estimate a cost of capital, that is, a hurdle rate, for an overseas project, division, or subsidiary. And they often want to apply different hurdle rates for operations in different countries, because of different degrees of risk involved. This chapter reviews ...