Deck 17: Multinational Cost of Capital and Capital Structure

Question 1

14)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 that of the U.S. and ____ than that of Japan.

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

Answer 1

A

Question 2

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

Answer 2

False

Question 3

12)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

Answer 3

C

Question 4

1)An argument for MNCs to have a debt-intensive capital structure is:

A) they are well diversified.
B) they can reduce the chance of bankruptcy.
C) it spreads the shareholder base.
D) it forces subsidiaries to pay dividends to shareholders.

Question 5

13)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 6

7)The term "global" target capital structure for an MNC represents the MNC's capital structure:

A) in the U.S.
B) relative to competitors across all countries.
C) where it has its largest subsidiary.
D) when consolidating all of its subsidiaries.

Question 7

16)The term "local target 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 8

19)Assume that the risk-free interest rate in the U.S. 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 had the same degree of financial leverage and the same operating characteristics as a U.S. firm, its cost of capital would be ____ than that of the U.S. firm.

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

Question 9

15)According to the text, the cost of debt:

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

Question 10

3)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 the above

Question 11

18.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 12

6)According to the text, MNCs can:

A) use only debt financing in foreign countries to support foreign subsidiaries.
B) use only equity financing in foreign countries to support foreign subsidiaries.
C) use only parent financing in foreign countries to support foreign subsidiaries.
D) none of the above

Question 13

5)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 14

10)One argument for why subsidiaries should be only partly-owned by the parent is:

A) that the potential conflict of interests between the MNC's managers and shareholders is avoided.
B) that the potential conflict of interests between the MNC's majority shareholders and minority shareholders is avoided.
C) that the potential conflict of interests between the MNC's existing creditors is avoided.
D) to motivate subsidiary managers by allowing them partial ownership.

Question 15

2)According to the text, there is evidence that the debt ratios (debt/capital) of MNCs based in:

A) the U.S. tend to be generally higher than MNCs headquartered in Japan and Germany.
B) China tend to be generally higher than MNCs headquartered in other non-U.S. countries.
C) the U.S. tend to be generally lower than MNCs headquartered in Japan and Germany.
D) A and B

Question 16

9)One argument for why subsidiaries should be wholly-owned by the parent is that the potential conflict of interests between the MNC's ____ is avoided.

A) managers and shareholders
B) majority shareholders and minority shareholders
C) existing creditors
D) managers and creditors

Question 17

4)Which of the following factors is not expected to generally have a favorable impact on the firm'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 the above

Question 18

8)According to the text, an MNC's "global" target capital structure is:

A) always debt-intensive.
B) always equity-intensive.
C) sometimes different from an MNC's "local" capital structures (at subsidiaries).
D) none of the above

Question 19

17)The term "global capital structure" is used in the text to represent the:

A) average capital structure of all MNCs across countries.
B) average capital structure of all domestic firms across countries.
C) capital structure of a subsidiary of a particular MNC.
D) capital structure of a particular MNC overall (including all subsidiaries).

Question 20

20)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 21

37)Assume the following information for Pexi 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%
German corporate tax rate = 40%
What is Pexi's cost of dollar-denominated equity?

A) 12.0%.
B) 11.2%.
C) 10.0%.
D) 7.2%.

Question 22

25)Which of the following is not a reason provided in the text regarding 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 23

39)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 24

33)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

38)Assume the following information for Brama 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%
German corporate tax rate = 40%
What is Brama's after-tax cost of dollar-denominated debt?

A) 7.0%.
B) 4.9%.
C) 8.0%.
D) 5.6%.

Question 26

21)Which of the following is not a factor that favorably affects an MNC's cost of capital, according to your text?

A) exchange rate risk.
B) size.
C) access to international capital markets.
D) international diversification.

Question 27

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

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

Question 28

30)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 29

35)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 the above

Question 30

31)In general, a firm ____ 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 the above

Question 31

27)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) B and D

Question 32

32)According to the CAPM, the required rate of return on 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 33

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

A) 21%.
B) 41%.
C) 16%.
D) 13%.
E) none of the above

Question 34

29)The ____ the MNC's cost of capital, the ____ will be a project's net present value for its proposed project with a given set of expected cash flows.

A) lower; higher
B) higher; higher
C) lower; lower
D) none of the above

Question 35

26)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) B and C
E) none of the above

Question 36

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

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

Question 37

36.When assuming that investors in the U.S. 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 38

28)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 the above

Question 39

22)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 40

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

Question 41

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

Question 42

48.Since the cost of funds can vary among markets, the 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 43

41.In general, an MNC's size, its access to international capital markets, and international diversification are unfavorable to an MNC's cost of capital.

Question 44

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

Question 45

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

Question 46

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

Question 47

51.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 48

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

Question 49

43.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 50

42.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 51

59.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 52

55.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.

Question 53

46.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 54

50.If an MNC's cash flows are more stable, it can probably handle more debt than an MNC with erratic cash flows.

Question 55

54.An MNC's size, its access to international capital markets, and international diversification are unfavorable to an MNC's cost of capital.

Question 56

56.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 57

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

Question 58

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

Question 59

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

Question 60

44.In the United States, government rescues are not as common as in 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 of other countries, everything else being equal.

Question 61

71)Most MNCs obtain equity funding:

A) in foreign countries.
B) in their home country.
C) through global offerings.
D) through private placements.

Question 62

64)An MNC can obtain equity by all of the following except:

A) retained earnings.
B) a global equity offering.
C) a domestic equity offering.
D) none of the above.

Question 63

69)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) C and D

Question 64

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

A) The stability of 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 65

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

A) The strength of host country currencies
B) The country risk in host countries
C) Political decisions to increase penalties for criminals
D) Tax laws in host countries

Question 66

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

A) 8.4%
B) 11.4%
C) 10%
D) None of the above

Question 67

62)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 the above

Question 68

70)____ 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 69

61)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) B and C
E) none of the above

Question 70

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

A) 10.80%
B) 12.40%
C) 9.20%
D) None of the above

Question 71

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

A) the risk-free rate of interest.
B) the market rate of return.
C) the stock's beta.
D) none of the above