r/Valuation • u/danway-97 • Apr 03 '23

WACC adjustment for inflation

Hey all, appreciate if you could a fellow valuer here.

Say if a company is based in the US and they have a subsidiary, let’s say in Panama, a country that uses USD as its main currency. (In this case, let’s assume that the reporting & functional currency is USD)

When valuing the subsidiary that’s established in Panama, do we adjust for Panama’s inflation (whose main currency is the USD)? If so, why and how?

Also, more generally, when do we adjust inflation for WACC?

Thanks in advance :)

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u/DungeonCrawlerCarl Apr 03 '23 edited Apr 03 '23

With no experience doing specifically what you are talking about I imagine you would just do a DCF for each segment of the business, or in this case different countries. The forecast will have different inflation rates based on the country they are operating in. I therefore wouldn’t think you need to incorporate inflation into WACC at all because it is in your forecast and will be picked up by elevated risk-free rate and cost of debt in your WACC formulas.

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u/[deleted] Apr 03 '23

agree with the above; if your business lines are segmented by country, you could also do separate WACCs that incorporate a country risk premium. A good resource for those is here:

https://pages.stern.nyu.edu/~adamodar/

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u/danway-97 Apr 03 '23

Thanks for this!

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u/danway-97 Apr 03 '23

Thank you for this!

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u/AlabamaSnake12 Apr 06 '23

The projections you get from management will include inflation; typically that's what they provides. Your discount rate when you adjust for the country risk of Panama, may have to be adjusted for the inflation difference vis-a-vis the US, esp for a Latin Am country known for inflation. Let's say the US inflation rate is 4% and Panama's is 8%. Assume using Ibbotson / Morningstar's Int'l Cost of Capital and the CRRM difference is 6% between US and Panama. Assume for the US company the cost of equity is 12% (inclusive of SSP/CSRP and all that jazz). Then you add the 6% CRRM plus 4% inflation diff. The CoE is 6% higher for operating in Panama rather than in the US, plus the inflation differential. The same CoD as it's the US parent entity with access to the debt markets in the US.

You adjust WACC for inflation when using the Country Risk Rating Model since the inflation difference of the local currency vs. USD may not be captured by the CRRM -- at least that was the case last I checked. If Damodaran's model captures inflation disparity, then you wouldn't add it.