Chapter 17 4
Chapter 17 4
Chapter 17 4
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17
Multinational Cost of Capital and
Capital Structure
Chapter Objectives
This chapter will:
A. Explain why the cost of capital of MNCs differs from that of
domestic firms
B. Explain why there are differences in the costs of capital
among countries
C. Explain how to account for the cost of capital when assessing
new international projects
D. Explain how corporate and country characteristics are
considered by an MNC when it establishes its capital structure
E. Explain the interaction between subsidiary and parent
financing decisions
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Background on Cost of Capital
1. Equity:
a. Cost of retained earnings: opportunity cost of what the
existing shareholders could have earned if they had received
dividends.
b. Cost of new common equity: opportunity cost of what the
existing shareholders could have earned if they had invested
their funds elsewhere
2. Debt:
a. Advantage: interest payments are tax deductible
b. Disadvantage: higher interest expense could lead to higher
probability that the firm will be unable to meet expenses.
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Comparing the Costs of Equity and Debt
where
D E
kc kc weighted d (1 t ) cost
kaverage of capital
k e
DE DE
D amount of the firm’s debt
kd before-tax cost of its debt
t corporate tax rate
E firm’s equity
ke cost of financing with equity
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Domestic versus MNC Cost of Capital
1. Size of firm
2. Access to international capital markets
3. International diversification
4. Exposure to exchange rate risk
5. Exposure to country risk
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Exhibit 17.1 Searching for the Appropriate
Capital Structure
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Exhibit 17.2 Summary of Factors That Cause the Cost of
Capital of MNCs to Differ From That of Domestic Firms
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Cost of Equity Comparison Using the CAPM
ke = Rf + B(Rm – Rf)
Where
ke = required return on stock
Rf = risk-free rate of return
Rm = market return
B = beta of stock
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The CAPM
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Costs of Capital Across Countries
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Cost of Capital of Foreign Projects
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Net Present Value Considerations
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The MNC’s Capital Structure Decision:
Influence of Corporate Characteristics
1. Stability of MNC’s cash flows
2. MNC’s credit risk
3. MNC’s access to retained earnings
4. MNC’s guarantees on debt
5. MNC’s agency problems
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The MNC’s Capital Structure Decision:
Influence of Country Characteristics
1. Stock restrictions in host countries
2. Stock valuation in host countries
3. Interest rates in host countries
4. Strength of host countries
5. Strength of host country currencies
6. Country risk in host countries
7. Tax laws in host countries
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Revising the Capital Structure
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Subsidiary versus Parent Capital Financing
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Exhibit 17.7 Effect of Global Conditions on
Financing
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