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Assignment uses two asset pricing model to estimate cost of equity as following
Multifactor Model which includes additional two risk factors namely Country risk premium and size
premium
𝑹𝒊 = 𝒓𝒇 + 𝜷𝒍 ∗ 𝑹𝒎𝒌𝒕 + 𝑹𝑪 + 𝑹𝑺
From the above model, we decide to use following proxies for the variables. We use , yields of USA
Tresuary Bills with maturity 30 years are used to estimate Risk-free Rate, next consensus of expert
assessments as a proxy for the market risk premium. Country risk premium and Betas are taken from
Damodaran website. Company size premium are taken from Duff & Phelps book. More information with
links is given in excel-file.
𝐷
Levered Beta is calculated as 𝛽𝐿 = 𝛽𝑈 ∗ (1 + (1 − 𝜏𝑐 ) ∗ 𝐸 in which 𝛽𝑈 as Unlevered beta of firms.
Since the betas are not available for Russian Firms, we estimated beta based on following steps:
1. Construct the market portfolio (including 20 biggest companies in Russia)
2. determine its expected excess return over the riskfree interest rate
3. Estimate the stock’s beta, or sensitivity to the market portfolio
The cost of equity is the return a company requires to decide if an investment meets capital return
requirements. Firms often use it as a capital budgeting threshold for required rate of return. A firm's cost of
equity represents the compensation the market demands in exchange for owning the asset and bearing the
risk of ownership.
If you are the company, the cost of equity determines the required rate of return on a particular project or
investment.
According to the CAPM model for two companies: Lenta and Farfetch, we obtained the following values
of cost of equity: 26.45% and 14.91%, respectively.
We can explain the higher indicator value for the tape by the fact that Tape is a more developed and
successful company, and Farfeth is very young and started an IPO only a month ago.
For the Russian company, beta is greater than for the European one, which can be explained as high
volatility of stocks on the Russian market and instability of the Russian stock market as a whole compared
to the United Kingdom. Therefore, the country tisk premium is also higher than the European one.
The difference in size premium we will explain as the fact that the company farfetch quite young.
A higher value of cost of equity for Lenta will provide its shareholders with greater profitability, which also
confirms our judgment that Lenta is more stable and more developed than Farfetch.
30.00%
25.00% 1.51%
2.88%
20.00% Size premium
15.00% Country risk premium
18.74% 2.68%
0.57%
10.00% B (levered) * rm
8.34% Rf
5.00%
3.32% 3.32%
0.00%
Lenta Farfetch