United States Dollar and Brazilian Industrial Conglomerate
【Summary】
Juan Lopez, a new associate in J.P. Morgan's Latin America M&A department, was assigned the task of valuing the telephone directory operation subsidiary of a large Brazilian industrial conglomerate. The subsidiary is Paginas Amarelas, which operates in three Latin countries such as Argentina, Brazil, and Chile. All cash flows have been converted to U.S. dollars, and present values computed for various discount rates. In order to the present value properly, he should determine the appropriate target rate of returns for dollar flows originating in Argentina, Brazil, and Chile.
Q1. What is the valuation problem here? In what currency are the cash flows denominated? In what currency should the discount rate denominated? Be sure you understand Exhibits 1, 2, 3, and 4 of the case.
Juan chose DCF model to determine fair value of those subsidiaries. To properly apply DCF model WACC is a key underlying assumption. WACC composes of cost of debt and cost of equity.
For cost of equity, Juan has some obstacles to determine it using CAPM model because following factors cannot be reasonably valued;
1. Risk-free rate is difficult to be determined because government bonds of those countries are not actually free of risk. Given that those governments had defaulted on principal and interest payments in the recent past.
2. Equity-risk premium cannot be reliably estimated. Equity market of each country has inadequate historical data e.g. historical stock prices, trading volume, dividend yield etc. This is because majority of companies are privately owned.
3. Beta cannot be appropriately calculated. There is no competitor of the subsidiary in each local market. Potential competitors are either doing many kind of businesses or too small to be compared. For cost of debt, each local operation does not significantly issue debt security independently in an international market. As a result, Juan has to use an estimate of the U.S. dollar rates as if each operation
Juan Lopez, a new associate in J.P. Morgan's Latin America M&A department, was assigned the task of valuing the telephone directory operation subsidiary of a large Brazilian industrial conglomerate. The subsidiary is Paginas Amarelas, which operates in three Latin countries such as Argentina, Brazil, and Chile. All cash flows have been converted to U.S. dollars, and present values computed for various discount rates. In order to the present value properly, he should determine the appropriate target rate of returns for dollar flows originating in Argentina, Brazil, and Chile.
Q1. What is the valuation problem here? In what currency are the cash flows denominated? In what currency should the discount rate denominated? Be sure you understand Exhibits 1, 2, 3, and 4 of the case.
Juan chose DCF model to determine fair value of those subsidiaries. To properly apply DCF model WACC is a key underlying assumption. WACC composes of cost of debt and cost of equity.
For cost of equity, Juan has some obstacles to determine it using CAPM model because following factors cannot be reasonably valued;
1. Risk-free rate is difficult to be determined because government bonds of those countries are not actually free of risk. Given that those governments had defaulted on principal and interest payments in the recent past.
2. Equity-risk premium cannot be reliably estimated. Equity market of each country has inadequate historical data e.g. historical stock prices, trading volume, dividend yield etc. This is because majority of companies are privately owned.
3. Beta cannot be appropriately calculated. There is no competitor of the subsidiary in each local market. Potential competitors are either doing many kind of businesses or too small to be compared. For cost of debt, each local operation does not significantly issue debt security independently in an international market. As a result, Juan has to use an estimate of the U.S. dollar rates as if each operation