Companies typically evaluate the returns expected from new investments against a “hurdle rate” or benchmark. Investments that earn returns in excess of the hurdle rate are expected to create value for shareholders and vice versa. Most companies set hurdle rates based on an analysis of their weighted average cost of capital (WACC). When considering investments outside their home country, they normally increase the hurdle rate to account for the additional perceived risks and volatilities associated with the opportunities.
Our capital markets research shows that in faster growing emerging economies such as Brazil, India and China, investors tend to demand lower returns on capital, not higher. We measured the “required return” by quantifying the median cash-on-cash return on capital delivered by companies valued at an enterprise value that is equal to the gross book value, which we call the Zero NPV (net present value) point. This relationship on average reveals the level of required return set by investors as the minimum required to create value.