Professional Documents
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17
Multinational Cost of Capital & Capital Structure
Cost of Capital
A firms capital consists of equity
(retained earnings and funds obtained by issuing stock) and debt (borrowed funds).
Cost of Capital
A firms weighted average cost of capital
kc = ( D ) kd ( 1 _ t ) + ( E ) ke
D+E D+E where D E kd t ke is the amount of debt of the firm is the equity of the firm is the before-tax cost of its debt is the corporate tax rate is the cost of financing with equity
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Cost of Capital
The interest payments on debt are tax
deductible. However, as interest expenses increase, the probability of bankruptcy will increase too.
are often given preferential treatment by creditors. They can usually achieve smaller per unit flotation costs too.
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MNCs are normally able to obtain funds through international capital markets, where the cost of funds may be lower.
International Diversification. M NCs may
have more stable cash inflows due to international diversification, such that their probability of bankruptcy may be lower.
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may be more exposed to exchange rate fluctuations, such that their cash flows may be more uncertain and their probability of bankruptcy higher.
Exposure to Country Risk. M NCs that
have a higher percentage of assets invested in foreign countries are more exposed to country risk.
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The probability distribution of NPVs can be computed to determine the probability that the foreign project will generate a return that is at least equal to the firms WACC. The MNC may estimate the cost of equity and the after-tax cost of debt of the funds needed to finance the project.
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