Feb. 12 (UPI) -- In earlier installments of this series on international project finance in Latin America, we examined how sovereign risk and currency volatility influence the cost of capital for long-term investments. This article turns to inflation, an equally decisive variable that operates quietly but relentlessly.
Unlike policy shocks or market swings, inflation functions as an invisible tax. It erodes the real value of money over time, raises financing costs, distorts investment decisions, and ultimately discourages productive projects. The contrasting experiences of Argentina and Bolivia illustrate how inflation reshapes the real cost of capital in ways that are often underestimated.
How inflation raises the cost of capital
Consider an investor evaluating a renewable energy project. The cost of capital -- the minimum return required to justify the investment -- is not an abstract concept. It is commonly estimated using the weighted average cost of capital (WACC), which combines the cost of debt and equity. For equity, investors typically rely on the Capital Asset Pricing Model (CAPM):
Cost of equity = risk-free rate + beta × market risk premium + country and inflation adjustments
