Determination of Market Values and Risk Premia of Multi-national Enterprises and Its Application to Transfer-pricing

Valuing a multi-national enterprise (MNE) using the discounted cash flow method (DCF) requires the joint determination of the market value of its equity (MVE) together with the equity risk premium (ERP) the firm should earn, since the latter is part of the discount rate used in the calculation of the MVE. This paper presents a theoretical derivation of how MVE and ERP can be calculated simultaneously under fairly general conditions and an application example. Besides firm data on free cash flow to equity the only external data needed are the risk-free rate of interest and a parameter indicating the required market risk premium per return volatility. The method presented allows for consistent valuation in particular of those firms that are not publicly listed and where ownership shares are not publicly traded. It also allows comparing the cash flows themselves to market returns on equally risky assets. This latter possibility is useful in transfer pricing, where the profit levels of dependent subsidiaries of MNEs are frequently under investigation.