Advanced Financial Management · International investment and financing decisions

Cost of Capital and Discount Rates for Overseas Projects

Updated 11 October 2026 · Fact-checked

A project-specific discount rate reflects the business risk of the overseas project, not the parent's own risk. Take a proxy company's equity beta, ungear it, regear it to the project's financing, then apply CAPM and WACC. Match the rate's currency to the cash flows, and consider whether investors hold globally diversified portfolios.

Understand Cost of Capital and Discount Rates for Overseas Projects

A discount rate is the return investors need for bearing the risk of a cash flow. If you use the parent's existing WACC for every project, you assume every project has the same risk as the parent. That is rarely true, and it is least true overseas.

The fix is a project-specific discount rate. Business risk depends on the activity and the country, so you look for a proxy company in the same industry, ideally in the same country. You take its equity beta, which mixes business risk and financial risk, and strip out the financial risk. The result is the asset beta (ungeared beta), which measures business risk only.

Next you add back financial risk. You regear the asset beta to the gearing that will apply to the project, or to the parent's target gearing. This gives an equity beta for the project. CAPM turns it into a cost of equity. You then combine it with the after-tax cost of debt in a WACC using the chosen gearing weights. Use the tax rate that applies to each step: the proxy's rate when ungearing, the project's rate when regearing.

The international CAPM question is: which market portfolio is the beta measured against? If shareholders hold only home-market shares, the home market is the relevant portfolio. If they hold globally diversified portfolios, the world market is. A foreign project may have low correlation with the home market. It then adds little systematic risk for a home-focused investor and gives a lower beta. Beta equals correlation times the ratio of the project's standard deviation to the market's, so low correlation lowers beta. Diversification benefits are only partly real. Political risk, currency risk and capital controls may not be captured by beta, so you may adjust cash flows, add a premium or use APV.

Finally, currency consistency. Cash flows in the foreign currency need a foreign-currency discount rate. Cash flows converted into the home currency need a home-currency rate. Never mix them. You can derive one rate from the other using expected inflation or interest rate differentials.

Key rules to remember

CAPM cost of equity: Ke = Rf + β × (Rm − Rf); Use the risk-free rate and market premium for the market the beta is measured against. In an international CAPM that may be the world market.
Ungearing an equity beta (debt beta assumed zero): βa = βe × Ve ÷ [Ve + Vd(1 − T)]; Use market values and the proxy company's tax rate. If a debt beta is given, include it: βa = βe × Ve/(Ve + Vd(1−T)) + βd × Vd(1−T)/(Ve + Vd(1−T)).
Regearing to a target capital structure (debt beta zero): βe = βa × [1 + Vd(1 − T) ÷ Ve]; Use the project's or parent's target gearing and the tax rate that applies to the project.
After-tax cost of debt: Kd(1 − T); Use the relevant tax rate. Redeemable debt needs the IRR of its cash flows to get Kd.
WACC: WACC = Ke × Ve ÷ (Ve + Vd) + Kd(1 − T) × Vd ÷ (Ve + Vd); Weights are market values at the target gearing for the project.
Beta from correlation: β = ρ(i,m) × σi ÷ σm; ρ is the correlation between the project's returns and the market portfolio. A different market portfolio gives a different beta.
Two-asset portfolio variance: σp² = w1²σ1² + w2²σ2² + 2 × w1 × w2 × ρ × σ1 × σ2; A lower correlation ρ gives more diversification and lower portfolio risk.
Fisher relationship: (1 + nominal rate) = (1 + real rate) × (1 + inflation); Use it to move between real and nominal rates.
Foreign-currency discount rate from home rate: (1 + foreign rate) = (1 + home rate) × (1 + foreign inflation) ÷ (1 + home inflation); The same logic works with nominal interest rate differentials. Use it to discount foreign-currency cash flows consistently.

How to solve Cost of Capital and Discount Rates for Overseas Projects questions

Use this order for any question asking you to estimate or justify a discount rate for an overseas project.

1Identify the project's business risk and its currency. Decide whether the parent's WACC is suitable. Say why it is or is not.
2Choose proxy companies in the project's industry, ideally in the host country. Note their equity betas, market-value gearing and tax rate.
3Ungear each proxy equity beta using its own gearing and tax rate to get an asset beta. If there are several proxies, average the asset betas.
4Regear the asset beta at the target gearing for the project, using the project's tax rate, to get the project equity beta.
5Calculate Ke using CAPM with the right Rf and market premium. Calculate the after-tax Kd, then the WACC at the target gearing.
6Check currency. If cash flows are foreign, convert the rate to the foreign currency using inflation or interest rate differentials. Otherwise convert the cash flows to the home currency and use the home rate.
7Comment on international CAPM and diversification. State which market portfolio is relevant, and whether beta captures political and currency risk.
8State your conclusion and its limits: proxy quality, constant gearing assumptions, and risks to deal with by adjusting cash flows or using APV.

Quickest way: Proxy beta to WACC in five lines

When to use it: Use it when the question gives a proxy company and target gearing and wants a number, with comment marks if time allows.

Write Vd(1 − T) for the proxy and find the ungearing factor Ve ÷ (Ve + Vd(1 − T)). Multiply it by βe to get βa.
Write the regearing factor 1 + Vd(1 − T) ÷ Ve for the project's gearing. Multiply it by βa to get βe.
Compute Ke = Rf + βe × premium, then the after-tax Kd.
Weight them at target gearing to get the WACC. Round only at the end.
Add two or three lines on diversification, political risk and currency. These earn the analysis and professional skills marks.

Common mistakes in Cost of Capital and Discount Rates for Overseas Projects

Using the parent's WACC for the overseas project without comment.
The WACC is in the question and it is the quickest route.
Fix: Use it only if the project has similar business risk and financing. Otherwise build a proxy-based rate, or explain why the parent's rate is acceptable.
Regearing a proxy's equity beta directly without ungearing first.
Students forget that the proxy's gearing is built into its beta.
Fix: Always ungear to the asset beta first. Then regear to the project's gearing.
Using the wrong tax rate or book values in the gearing formulas.
Students use one tax rate throughout, or use balance sheet figures because they are easy to find.
Fix: Use market values. Use the proxy's tax rate when ungearing and the project's tax rate when regearing.
Mixing currencies: discounting foreign-currency cash flows at a home-currency rate, or the reverse.
The rate is given in one currency and the cash flows are in another, and students do not check.
Fix: Note the currency of the cash flows and the rate. Convert one to match the other using inflation or interest differentials.
Claiming that international diversification always lowers the project's discount rate.
Students remember the correlation argument but not its conditions.
Fix: It lowers the beta only if the relevant market portfolio has a low correlation with the project. It does not reduce political risk or currency risk, and it depends on shareholders' diversification.
Stopping at the number without any comment.
The calculation feels like the whole answer.
Fix: State assumptions and limits, such as proxy quality, stable gearing and risks not captured by beta. Written comment and professional skills marks depend on it.

Worked examples

Example 1

A home-country company is evaluating a project in another country. A listed proxy company in the host country has an equity beta of 1.2, market values of equity 300 and debt 100 (same currency units), and a tax rate of 25%. The project will be financed at 20% debt and 80% equity by market value, and the project tax rate is 30%. The risk-free rate is 4% and the market risk premium is 5%. The pre-tax cost of debt is 6%. Assume the debt beta is zero. Calculate a project-specific WACC.

Show the solution

Ungear the proxy: Vd(1 − T) = 100 × 0.75 = 75. Ve + Vd(1 − T) = 300 + 75 = 375.
βa = 1.2 × 300 ÷ 375 = 0.96.
Regear at target gearing: Vd ÷ Ve = 20 ÷ 80 = 0.25. βe = 0.96 × [1 + 0.25 × (1 − 0.30)] = 0.96 × 1.175 = 1.128.
Ke = 4% + 1.128 × 5% = 4% + 5.64% = 9.64%.
After-tax Kd = 6% × (1 − 0.30) = 4.2%.
WACC = 0.80 × 9.64% + 0.20 × 4.2% = 7.712% + 0.84% = 8.552%.

Answer: The project-specific WACC is about 8.55%. It reflects the proxy's business risk, the project's target gearing and the project's tax rate.

Example 2

An overseas project's returns have a standard deviation of 30%. Its correlation with the home market is 0.4 and the home market standard deviation is 20%. Its correlation with the world market is 0.7 and the world market standard deviation is 15%. The risk-free rate is 3%. The home market premium is 6% and the world market premium is 5%. (a) Calculate the cost of equity on a home-market basis and on a world-market basis. (b) The home-currency discount rate is 9%. Expected inflation is 3% at home and 6% in the project country. Find the equivalent discount rate for cash flows in the project country's currency.

Show the solution

(a) Home beta = 0.4 × 30 ÷ 20 = 0.6. Ke = 3% + 0.6 × 6% = 3% + 3.6% = 6.6%.
World beta = 0.7 × 30 ÷ 15 = 1.4. Ke = 3% + 1.4 × 5% = 3% + 7% = 10%.
Interpretation: the right figure depends on how shareholders diversify. If they hold mainly home shares, the home basis is relevant. If they hold globally diversified portfolios, the world basis is relevant. Neither basis captures political risk or currency risk.
(b) (1 + foreign rate) = 1.09 × 1.06 ÷ 1.03.
1.06 ÷ 1.03 = 1.029126. Multiply by 1.09: 1.029126 × 1.09 = 1.121747.
Foreign rate = 1.121747 − 1 = 12.17% (to two decimals).

Answer: (a) Cost of equity is 6.6% on the home basis and 10% on the world basis. Use the one that matches shareholders' diversification, and say so. (b) The equivalent discount rate for the project country's currency cash flows is about 12.17%.

Exam tips

Show every step: ungear, regear, Ke, Kd, WACC. Method marks are awarded even if one input is wrong.
Say which tax rate and which gearing you use at each step. State that you assume a zero debt beta if none is given.
Check the currency of every cash flow and rate before you discount. Write a one-line note on it.
Link comments to the scenario: the country, the industry, the shareholders' diversification. Generic points score less and earn fewer professional skills marks.
Where beta cannot capture political or currency risk, say so and suggest adjusting cash flows or using APV as a better treatment.

Practice questions from International investment and financing decisions

Cost of Capital and Discount Rates for Overseas Projects in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Actuarial Core Principles (IAI)Risk Discount Rate and Cost of Capital

Cost of Capital and Discount Rates for Overseas Projects: frequently asked questions

Why not use the parent company's WACC for an overseas project?

The parent's WACC reflects the parent's business risk and financing. An overseas project may have different business risk, a different country risk and different financing. Use the parent's WACC only if risk and financing are similar, and say why.

What is the international CAPM in ACCA AFM?

It is CAPM applied with a world market portfolio when investors hold globally diversified portfolios. The beta is measured against the world market and the premium is the world market premium. The key idea is that diversification across countries can reduce systematic risk if correlations are low.

Do I always need a proxy company?

Use one when the project's business risk differs from the parent's, which is the usual exam case. If the question gives the project's own beta, use that. If the risk is similar to the parent's, you may use the parent's beta and WACC with justification.

How do I deal with political risk in the discount rate?

Beta does not fully capture political risk. A common approach is to adjust the expected cash flows for blocked funds, expropriation or tax changes. APV can also be used. Adding an arbitrary premium to the discount rate is weaker and needs clear justification.