According to our recent survey, the average Indonesia-listed company pays 11.6% for the money it uses to run its business. This rate is the Weighted Average Cost of Capital (WACC). About 30% of these funds come from borrowing, while the remainder comes from the more expensive equity market.
A key input to company valuation is the calculation of the cost of capital. Analysts consider the cost of debt and the cost of equity to calculate this value. The mix of these two sources of capital that a business uses determines its WACC.
Companies use this cost of capital as a “hurdle” rate, seeking projects that have profitability above this minimum desired return. Financial analysts use the cost of capital as an assessment of the riskiness of the company’s future cash flows.
When an analyst assigns a high cost of capital, she thinks that the company’s future cash flows are worth much less than their nominal forecast value. In such a case, she “discounts”—or reduces—those future cash flows by this high cost of capital.
It may be helpful to think about discounting with a personal example. Imagine you lent one hundred dollars to a stranger for one week vs. lending the same amount to your most trusted friend. For the stranger, you assign a high risk that you will get that money back; hence you will discount (reduce) its one-hundred-dollar value. If you thought there was a 50% chance you would get the one hundred dollars back and an equal chance you would get nothing, the discounted value would be fifty dollars. For the friend you may have a minimal reduction so the discounted value could be $95.
The Indonesia stock market has about 521 listed companies.
The top 5% of listed companies (26 companies) account for 63% of the market capitalization, making Indonesia a relatively highly concentrated market in ASEAN. The most concentrated market in ASEAN is Singapore, where the top 5% of listed companies (36 companies) account for 74% of the market capitalization.
In this research, we reviewed available research and surveyed four sell-side research operations in Indonesia. The survey collected data related to 17 different Indonesia stock exchange listed companies.
The average WACC that analysts calculated in their recent discounted cash flow valuations was 11.6%. This average did not take into consideration the WACC for individual companies or sectors but just attempted to find the average for all surveyed companies used in Indonesia.
Of the total observations, the highest WACC was 16.3%, and the lowest was 9.0%.
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