Average cost of equity is ~15%, stagnant despite decline in interest rates: EY Report
6 April 2017
- Cost of equity in India is 4% more than developed countries (measured in dollar terms)
- Cost of equity is highest in sectors such as real estate and engineering, procurement and construction (EPC)
- Additional risk premium justifiable when considering strategic investment in start-ups
According to the latest edition of the Cost of Capital Survey, EY’s report on capital, the average cost of equity in India is ~15%. The cost of equity has remained constant since the previous cost of capital survey undertaken by EY in 2014, over a period in which interest rates have declined by 200 basis points.
The stagnancy in cost of equity despite falling interest rates is indicative of a perceived increase in the risk in the economy, leading to companies expecting a relatively higher premium for equity investments. The survey also found that the average adjustment in cost of equity for company-specific factors (represented by “alpha”) has gone up during the same period, further reinforcing the perception of increased risk in equity investments.
The findings also highlight the fact that, measured in dollars, the cost of equity in India is higher as compared to the developed countries by about 4%. While this premium is in line with theoretical models of cross country cost of equity, it makes Indian acquirers less competitive in instances where they are bidding for acquisition targets or projects, and competing with potential acquirers from developed countries with a lower cost of capital.
Navin Vohra, Partner and Leader – Valuations and Business Modelling, EY, says, “The cost of capital is an important variable in capital budgeting and M&A decisions. Investor surveys are a vital technique to measure cost of capital and the report attempts to provide an objective benchmark to India Inc. on a periodic basis, and help companies in optimizing their cost of capital.”
As per the survey, the cost of equity is highest in sectors such as real estate and EPC, while FMCG and capital goods enjoy the lowest cost of equity. Interestingly, the cost of equity across sectors has converged since the last survey. Most respondents acknowledged that an additional risk premium is justifiable when considering strategic investments in start-ups and provided their views on the quantum, which varied across industries.
The cost of capital survey India 2017 is focused to understand the threshold cost of equity that India Inc. used for its capital allocation and investment decisions and the process by which practicing finance professionals in the industry make capital costing decisions. The survey this year, covered a sample size of 135 response sets from finance professionals in companies across various sectors and representation from listed, unlisted, Indian and multinational companies.
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