Deck 17: Multinational Capital Structure and Cost of Capital

Question 1

The capital asset pricing model (CAPM) suggests that the required return on a firm's stock is a positive function of the risk-free rate of interest and the market rate of return and a negative function of the stock's beta.

Answer 1

False

Question 2

If a parent MNC backs the debt of a foreign subsidiary, the borrowing capacity of the parent might be reduced because creditors may not be willing to provide as many funds to the parent if those funds may possibly be needed to rescue the subsidiary.

Answer 2

True

Question 3

An MNC's cost of equity is unrelated to the local risk-free rate.

Answer 3

False

Question 4

When assuming that investors in the United States are most concerned with their exposure to the U.S. stock market, it is acceptable to use the U.S. market when measuring a U.S.-based MNC's project's beta.

Question 5

The cost of an MNC's capital can be measured as the cost of its debt plus the cost of its equity, with appropriate weights applied to reflect the percentages of debt and equity.

Question 6

There is an advantage to using equity rather than debt financing because dividend payments are tax deductible.

Question 7

It is always advantageous to use foreign debt to finance a foreign project, particularly in developing countries.

Question 8

When MNCs pursue international projects that have a high potential for return, but also increase their risk, this increases the return to the bondholders that provided credit to the MNCs.

Question 9

In the United States, government rescues of failing firms are not as common as they are in some other countries. Assuming that this is expected to continue in the future, the risk premium on a given level of debt would be higher for U.S. firms than for firms in countries where government rescues are more common, everything else being equal.

Question 10

Since the cost of funds can vary among markets, an MNC's access to the international capital markets may allow it to attract funds at a lower cost than that paid by domestic firms.

Question 11

Normally, each subsidiary of an MNC will issue its own stock where it does business.

Question 12

Because their economies have lower growth, the cost of debt in industrialized countries is much higher than the cost of debt in many less developed countries.

Question 13

Country differences, such as differences in the risk-free interest rate and differences in risk premiums across countries, can cause the cost of capital to vary across countries.

Question 14

An MNC with stable cash flows can probably handle more debt than an MNC with erratic cash flows.

Question 15

An MNC may deviate from its target capital structure in each country where financing is obtained, yet still achieve its target capital structure on a consolidated basis.

Question 16

In general, an MNC's size, its access to international capital markets, and its international diversification increase the MNC's cost of capital.

Question 17

An MNC's cost of capital may differ from that of domestic firms because of the MNC's access to international capital markets, its exposure to exchange rate risk, and other characteristics.

Question 18

When a host country announces a plan to block funds remitted to the subsidiary's parent, the subsidiary is likely to use a strategy of increasing local debt financing.

Question 19

Assume a subsidiary is forced to borrow in excess of the MNC's optimal capital structure. Also assume that the parent company reduces its debt financing by an offsetting amount. Under this scenario, the cost of capital for the MNC overall could not have changed.

Question 20

Capital asset pricing theory would most likely suggest that the MNC's cost of capital is lower than that of domestic firms.

Question 21

Which of the following is not a characteristic that favorably affects an MNC's cost of capital, compared to the cost of capital for a domestic firm?

A) the MNC's exposure to exchange rate risk
B) the MNC's size
C) the MNC's access to international capital markets
D) the MNC's international diversification

Question 22

It is probably easier to estimate the cost of equity than it is to estimate the cost of debt.

Question 23

Because increased external financing by a foreign subsidiary reduces the external financing needed by the parent, such an action will not affect the MNC's overall cost of capital.

Question 24

The lower a project's beta, the ____ is the project's ____ risk.

A) lower; systematic
B) lower; unsystematic
C) higher; systematic
D) higher; unsystematic

Question 25

When a country's risk-free rate rises, the cost of equity to an MNC in that country _____, and the cost of debt to an MNC in that country ____, other things held constant.

A) increases; increases
B) increases; is not affected
C) is not affected; increases
D) is not affected; is not affected

Question 26

Which of the following is a corporate characteristic that may affect an MNC's capital structure decision?

A) the MNC's cash flow stability
B) the MNC's access to retained earnings
C) the MNC's credit risk
D) All of these may affect an MNC's capital structure decision.

Question 27

Capital asset pricing theory suggests that ____ risk of projects can be ignored and that ____ risk is relevant.

A) unsystematic; unsystematic
B) unsystematic; systematic
C) systematic; unsystematic
D) systematic; systematic

Question 28

The cost of capital incurred by U.S.-based MNCs is primarily driven by global stock market volatility.

Question 29

The capital asset pricing model suggests that the required return on a firm's stock is a positive function of:

A) the risk-free rate of interest.
B) the market rate of return.
C) the stock's beta.
D) All of these are correct.

Question 30

​Assume that an MNC has very stable cash flows and uses very little debt. Its cost of debt should be:

A) ​lower than its cost of equity.
B) ​higher than its cost of equity.
C) ​lower than the country's risk-free rate.
D) ​lower than its credit risk premium.

Question 31

In general, MNCs probably prefer to use ____ foreign debt when their foreign subsidiaries are subject to potentially ____ local currencies.

A) more; strong
B) more; weak
C) less; strong
D) less; weak
E) more; weak AND less; strong

Question 32

Based on the CAPM, the ____ the beta of a project, the ____ the required rate of return on that project.

A) higher; higher
B) lower; higher
C) higher; lower
D) lower; higher AND higher; lower
E) None of these are correct.

Question 33

According to the CAPM, the required rate of return on a stock is a positive function of all of the following except:

A) the risk-free rate of interest.
B) the market rate of return.
C) the stock's beta.
D) the company's earnings.

Question 34

An MNC's "global" capital structure is:

A) the MNC's capital structure in the United States.
B) the MNC's capital structure relative to the structures of competitors across all countries.
C) the MNC's capital structure where it has its largest subsidiary.
D) the combination of the capital structures of the parent and all of its subsidiaries.

Question 35

An MNC's capital represents all of the following except its proceeds received from:

A) issuing commercial paper.
B) issuing stock.
C) issuing long-term bonds.
D) retained earnings.

Question 36

The credit risk premium on an MNC's loans tends to be lower in the United States than in most other countries because the U.S. government stands ready to rescue failing firms.

Question 37

The capital asset pricing theory is based on the premise that:​

A) ​only unsystematic variability in cash flows is relevant.
B) ​only systematic variability in cash flows is relevant.
C) ​both systematic and unsystematic variability in cash flows are relevant.
D) ​neither systematic nor unsystematic variability in cash flows is relevant.

Question 38

____ are beneficial because they may reduce transaction costs. However, MNCs may not be able to obtain all the funds that they need.​

A) ​Private placements
B) ​Domestic equity offerings
C) ​Global equity offerings
D) ​Global debt offerings

Question 39

​Other things being equal, countries with relatively ____ populations and ____ inflation are more likely to have a low cost of capital.

A) ​young; high
B) ​old; high
C) ​old; low
D) ​young; low

Question 40

Which of the following is least likely to influence an MNC's capital structure?

A) ​stability of the MNC's cash flows
B) ​the MNC's credit risk
C) ​the MNC's access to earnings
D) ​the MNC's decision to invest excess cash in a Treasury bill rather than in a bank

Question 41

​According to the text, the cost of debt in each country:

A) ​is somewhat stable over time.
B) ​changes over time, and these changes are negatively correlated among countries.
C) ​changes over time, and these changes are positively correlated among countries.
D) ​changes over time, and these changes are not correlated among countries.

Question 42

The U.S. risk-free rate is currently 3 percent. The expected U.S. market return is 10 percent. Solso, Inc. is considering a project that has a beta of 1.2. What is the cost of dollar-denominated equity?

A) 8.4 percent
B) 11.4 percent
C) 10.0 percent
D) None of these are correct.

Question 43

Based on the factors that influence a country's cost of capital, the cost of capital in less developed countries is likely to be ____ than in the United States and ____ than in Japan.​

A) ​higher; higher
B) ​higher; lower
C) ​lower; lower
D) ​lower; higher

Question 44

If the parent ____ the debt of the subsidiary, the subsidiary's borrowing capacity might be ____.

A) does not back; increased
B) backs; reduced
C) does not back; reduced
D) backs; increased
E) does not back; reduced AND backs; increased

Question 45

Which of the following is not a reason provided in the text for why the cost of debt can vary across countries?

A) differences in the risk-free rate
B) a high price/earnings multiple
C) differences in the credit risk premium
D) differences in demographics

Question 46

Assume that the risk-free interest rate in the United States is the same as that in Country M. Assume that the government of Country M is more likely to rescue local firms that experience financial problems. Other things being equal, Country M's firms are likely to use a ____ degree of financial leverage than U.S. firms. If a firm based in Country M has the same degree of financial leverage and the same operating characteristics as a U.S. firm, its cost of capital will likely be ____ than that of the U.S. firm.​

A) ​higher; higher
B) ​higher; lower
C) ​lower; lower
D) ​lower; higher

Question 47

Which of the following factors is generally not expected to have a favorable impact on an MNC's cost of capital according to the text?

A) easy access to international capital markets
B) high degree of international diversification
C) high exposure to exchange rate fluctuations
D) All of these are correct.

Question 48

One argument for why subsidiaries should be wholly owned by the MNC parent is that parent ownership avoids a potential conflict of interest between the:

A) parent's managers and board of directors.
B) parent and managers at the subsidiary who are minority shareholders.
C) parent and existing creditors.
D) subsidiary's managers and creditors.

Question 49

According to your text, which of the following is not a factor that increases an MNC's cost of capital?

A) ​higher exposure to exchange rate risk
B) ​higher exposure to country risk
C) ​an increase in the risk-free interest rate
D) ​an increase in the size of the MNC

Question 50

According to the text, the cost of capital for an international project will:

A) always be greater than the firm's cost of capital.
B) always be less than the firm's cost of capital.
C) always be the same as the firm's cost of capital.
D) None of these are correct.

Question 51

An argument for an MNC to have a debt-intensive capital structure is that:

A) it can reduce the MNC's exposure to exchange rate risk on earnings remitted by subsidiaries to the parent.
B) it can reduce the chance of bankruptcy.
C) it spreads the shareholder base.
D) it forces subsidiaries to pay dividends to shareholders.

Question 52

Which of the following is not an external source of debt for an MNC?

A) a private placement of bonds
B) borrowing from a financial institution
C) a domestic bond offering
D) borrowing in the federal funds market

Question 53

In general, MNCs probably prefer to use ____ foreign debt when their foreign subsidiaries are subject to ____ local interest rates.

A) more; low
B) more; high
C) less; low
D) more; high AND less; low
E) None of these are correct.

Question 54

In general, an MNC that is ____ exposed to exchange rate fluctuations will usually have a ____ distribution of possible cash flows in future periods.

A) more; narrower
B) less; wider
C) more; wider
D) None of these are correct.

Question 55

One argument for why subsidiaries should be allowed to issue their own stock is that:​

A) ​it prevents a potential conflict of interests between the MNC's managers and shareholders.
B) ​it prevents a potential conflict of interests between the MNC's majority shareholders and minority shareholders.
C) ​it prevents a potential conflict of interests between the MNC's existing creditors.
D) ​having local investors as minority shareholders may offer some protection against adverse actions by the local government.

Question 56

An MNC's "global" target capital structure is:

A) always debt intensive.
B) always equity intensive.
C) sometimes different from the MNC's "local" capital structure (at a subsidiary).
D) None of these are correct.

Question 57

Zoro Corp. has a beta of 2.0. The risk-free rate of interest is 5 percent, and the return on the stock market overall is expected to be 13 percent. What is the required rate of return on Zoro stock?

A) 21 percent
B) 41 percent
C) 16 percent
D) 13 percent
E) None of these are correct.
​

Question 58

The term "local capital structure" is used in the text to represent the:​

A) average capital structure of local firms where the MNC's subsidiary is based.​
B) ​average capital structure of local firms where the MNC's parent is based.
C) ​capital structure of a subsidiary of a particular MNC.
D) ​capital structure of a particular MNC overall (including all subsidiaries).

Question 59

Which of the following is not a source of equity for an MNC?

A) retained earnings
B) a global equity offering
C) a domestic equity offering
D) All of these are sources of equity for an MNC.

Question 60

Werner Corporation has a target capital structure that consists of 40 percent debt and 60 percent equity. Werner can borrow at an interest rate of 10 percent. Also, Werner has determined its cost of equity to be 14 percent. Werner's tax rate is 20 percent. What is Werner's weighted average cost of capital?

A) 10.8 percent
B) 12.4 percent
C) 9.2 percent
D) 11.6 percent

Question 61

To the extent that individual economies are ____ each other, net cash flows from a portfolio of subsidiaries should exhibit ____ variability, which may reduce the probability of bankruptcy.​

A) ​dependent on; less
B) ​dependent on; more
C) ​independent of; less
D) ​independent of; more

Question 62

Assume the following information for Vermont Co., a U.S-based MNC that needs funding for a project in Germany: U.S. risk-free rate = 4%
German risk-free rate = 5%
Risk premium on dollar-denominated debt provided by U.S. creditors = 3%
Risk premium on euro-denominated debt provided by German creditors = 4%
Beta of project = 1.2
Expected U.S. market return = 10%
U)S. corporate tax rate = 30% (federal and state combined)
German corporate tax rate = 40%
What is Vermont's after-tax cost of dollar-denominated debt?

A) 7.0 percent
B) 4.9 percent
C) 8.0 percent
D) 5.6 percent

Question 63

Capital asset pricing theory would most likely suggest that the cost of capital is generally ____ for ____.

A) higher; MNCs
B) lower; domestic firms
C) lower; MNCs
D) None of these are correct.

Question 64

A firm's cost of ____ reflects an opportunity cost: what the existing shareholders could have earned if they had received the earnings as dividends and invested the funds themselves.

A) debt
B) retained earnings
C) short-term loans
D) None of these are correct.

Question 65

When a firm issues stock in a country with weak laws on corporate disclosure and little legal protection for shareholders, the stock will generally be sold at a relatively ______ price, so the firm incurs a _____ cost of equity. ​

A) ​low; low
B) ​low; high
C) ​high; high
D) ​high; low

Question 66

Which of the following is not a host country characteristic than can affect an MNC's capital structure decision?

A) the strength of the host country currency
B) the country risk in the host country
C) political decisions to increase penalties for criminals in the host country
D) tax laws in the host country
Answer Key

Question 67

Other things being equal, the financial leverage of MNCs will be higher if the governments of their home countries are ____ likely to rescue them (in the event of failure), and if their home countries are ____ likely to experience a recession.​

A) ​more; more
B) ​less; more
C) ​less; less
D) ​more; less

Question 68

The ____ an MNC, the ____ its cost of capital is likely to be.

A) larger; higher
B) larger; lower
C) smaller; lower
D) larger; higher AND smaller; lower