India’s 10 year government bond yield is 7.31%. Given the fact that India is a Baa3 rated country, there is a default spread component in the 10 year government bond yield.
India’s true risk free rate % should be – 7.31% minus 1.87% ( i.e default spread at Baa3 rating) = 5.44%
Now let’s focus on 5.44% growth in Indian Economy:
Any Economy is driven by a basket of large companies and small/mid cap companies. I assume that large companies contribute to about 4% to the economy’s growth and rest 1.44% by small/mid cap companies.
When we are doing a terminal value calculation, we assume that the company (that we are valuing) is already a mature company (as it’s going on forever) and that’s why the growth rate in perpetuity in India is 4%.
The same way, growth rate in perpetuity in US$ will be around 2% (given their risk free rate and composition of economy).
One question that you can have is, why can’t we put a growth rate in perpetuity of 7% or 8% or 10%?
It’s because if you do that, you are implicitly assuming that the company will outgrow the whole Indian Economy, which is a pipe dream! If Indian Economy is growing at 5.44%, your company will grow at a rate lower than that.
Hope that helps!
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