Other Complications in Valuing Emerging-Markets Companies  701
Estimating the After-Tax Cost of Debt
In most emerging economies, there are no liquid markets for corporate bonds, so 
little or no market information is available to estimate the cost of debt. However, 
from a global investor’s perspective, the cost of debt in local currency should 
simply equal the sum of the dollar (or euro) risk-free rate, the systematic part 
of the credit spread (which depends on the debt’s beta; see the section titled 
“Estimating the After-Tax Cost of Debt in Chapter 15), and the inflation differ-
ential between local currency and dollars (or euros). Most of the country risk 
can be diversified away in a global bond portfolio. Therefore, the systematic 
part of the default risk is probably no larger than that of companies in inter-
national markets, and the cost of debt should not include a separate country 
risk premium.8 Furthermore, companies in countries like Brazil often hold large 
amounts of cash to provide liquidity and minimize their net debt.
The marginal tax rate in emerging markets can be very different from the 
effective tax rate, which often includes investment tax credits, export tax cred-
its, taxes, equity or dividend credits, and operating loss credits. Few of these 
arrangements provide a tax shield on interest expense, and only those few 
should be incorporated in the after-tax-cost-of-debt component of the WACC. 
Other taxes or credits should be modeled directly in the cash flows.
Estimating Capital Structure and WACC
Having estimated the cost of equity and after-tax cost of debt, we need debt 
and equity weights to derive an estimate of the weighted average cost of capi-
tal. In emerging markets, many companies have unusual capital structures 
compared with their international peers. One reason is, of course, the country 
risk: the possibility of macroeconomic distress makes companies more con-
servative in setting their leverage. Another reason could be anomalies in the 
local debt or equity markets. In the long run, when the anomalies are cor-
rected, the companies should expect to develop a capital structure similar to 
that of their global competitors. You could forecast explicitly how the com-
pany evolves to a capital structure that is more like global standards. In that 
case, you should consider using the adjusted-present-value (APV) approach, 
discussed in Chapter 10.
Other Complications in Valuing Emerging-Markets 
Companies
Other complications that should be considered in valuing emerging-markets 
companies include consistent macroeconomic parameters, accounting differ-
ences, nonoperating assets, and inefficient capital markets.
8 This explains why multinationals with extensive emerging-market portfolios—companies such as 
Coca-Cola and Colgate-Palmolive—have a cost of debt that is no higher than that of their mainly U.S.-
focused competitors.