Chapter 18 Multinational Cost of Capital and Capital Structure

Chapter 18 Multinational Cost
of Capital and Capital

Structure
Background on Cost of
Capital(1)
A firm’s capital consists of
equity(retained earnings and funds
obtained by issuing stock) and
debt(borrowed funds)
 There is an advantage to using debt
rather than equity as capital because
the interest payments on debt are tax
deductible
Background on Cost of
Capital(2)
 The trade off between debt’s advantage
and its disadvantage
 It is favorable to increase the use of
debt financing until the point at which
the bankruptcy probability becomes
large enough to offset the tax
advantage of using debt
Cost of Capital for MNCs
 Size of firm
 Access to international capital markets
 International diversification
 Exposure to exchange rate risk
 Exposure to country risk
Cost of Capital Comparison
Using the CAPM(1)
 To assess how required rates of return of
MNCs differ from those of purely domestic
firms, the CAPM can be applied
 The CAPM suggests that the required return
on a firm’s stock is a positive function of
(1)the risk-free rate of interests,(2)the market
rate of return and (3)the stock’s beta
 The beta represents the sensitivity of the
stock’s returns to market returns
Cost of Capital Comparison
Using the CAPM(2)
 Unsystematic risks vs systematic risks
 Capital asset pricing theory would suggest that
the MNC cost of capital is generally lower than
that of domestic firms
 Since markets are becoming most integrated
over time, one could argue that a world market is
more appropriate than a U.S. market for US-
based MNCs
 MNC may attempt to take full advantage of the
favorable aspects that reduce its cost of capital
Cost Capital Across Countries
 Country differences in the cost of debt
 Difference in the risk-free rate
 Difference in the risk premium
 Comparative costs of debt across countries
 Country difference in the cost of equity
 Combining the costs of debt and equity
Using the cost of capital for
assessing foreign projects
 When the MNC’s parent proposes an investment
in a foreign project that has the same risk as the
MNC itself, it can use its weighted average cost
of capital as the required rate of return for the
project
 An alternative method of accounting for a foreign
project’s risk is to adjust the firm’s weighted
average cost of capital for the risk differential
 There is no perfect formula to adjust for the
project’s unique risk
The MNC’s Capital Structure
Decision
 Influence of corporate characteristics
 Stability of MNC’s cash flows
 MNC’s credit risk
 MNC’s access to earnings
Influence of Country
Characteristics
 Stock restrictions in host countries
 Interests rates in host countries
 Strength of host country currencies
 Country risk in host countries
 Tax laws in host countries
 Summary of country characteristics
Creating the Target Capital
Structure(1)
 An MNC may deviate from its target capital
structure in each country where financing is
obtained
 Consider that country A does not allow MNCs
with headquarters elsewhere to list their
stocks on its local stock exchange
 Consider a second example, in which country
B allows the MNC to issue stock there and list
its stock on its local exchange
Creating the Target Capital
Structure(2)
 As a third example,consider an MNC that
desires financing in country C, which is
experiencing political turmoil
 The ideal sources of funds for all countries
will not necessarily sum to match the global
target capital structure
 The strategy of ignoring a “local”target capital
structure in favor of a global target capital
structure is rational as long as it is acceptable
by foreign creditors and investors
Local Ownership of Foreign
Subsidiaries
 Some MNCs may allow a specific foreign subsidiary
to issue stock to local investors or employees as a
means of infusing equity into the subsidiary
 One concern about a partially owned foreign
subsidiary is a potential conflict of interest
 Some countries will allow an MNC to establish a
subsidiary there only if the subsidiary can sell shares
 One possible advantage of a partially owned
subsidiary is that it may open up additional
opportunities within the host country

Chapter 18 Multinational Cost of Capital and Capital Structure

Uploaded by

Copyright:

Available Formats

Chapter 18 Multinational Cost of Capital and Capital Structure

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Chapter 18 Multinational Cost of Capital and Capital Structure

Uploaded by

Copyright:

Available Formats

Chapter 18 Multinational Cost

of Capital and Capital

You might also like