Capital Judgments

By Ramesh Akkineni

From an article by Arun Shourie

Anyone with the slightest acquaintance with valuation — including the CAG — knows that risk differs from sector to sector: hence the discount factor, the cost of capital will differ from sector to sector.

The risk for which a borrower in the tourism sector will have to compensate the lender will be much greater than a borrower would have to in the aluminium sector. The risk for which a borrower in the steel sector would have had to compensate a lender five years ago was much higher than it is today — the demand from China having raised steel prices to levels inconceivable five years ago.

Nor can recent trends or current levels be projected into the indefinite future. Today petroleum prices have reached unprecedented heights. Should a lender advancing money to a company investing in the petroleum sector assume that these levels will continue, or reach $100, or fall back to $50? Judgments will differ.

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