Deck 17: Multinational Cost of Capital and Capital Structure

Question 1

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.

Answer 1

True

Question 2

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 struc tures (at subsidiaries).
D) none of the above

Answer 2

C

Question 3

Assume that the riskfree 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

Answer 3

B

Question 4

One argument for why subsidiaries should be only partlyowned 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 offer some protection against threats of any adverse actions by the host government.

Question 5

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

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

Question 6

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

A) they are well diversified.
B) foreign government tax rules may change over time.
C) exposure to exchange rate fluctuations.
D) exposure to fund blockage.

Question 7

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

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

Question 8

When an MNC's firm's cost of capital rises,it would be _______ likely to divest an existing project,other things held constant.

A) more
B) less
C) neither;there is no effect
D) neither;MNCs do not ever divest projects

Question 9

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) volatile exchange rate fluctuations.
D) all of the above

Question 10

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 11

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 12

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

Question 13

The cost of capital for MNCs based in the U.S.has been generally _______ than MNCs based in Germany and _______ than MNCs based in Japan.

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

Question 14

According to the text,MNCs:

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 15

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 16

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) the United Kingdom 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 headquar tered in Japan and Germany.
D) A and B

Question 17

According to the text:

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

Question 18

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 19

One argument for why subsidiaries should be whollyowned by the parent is that:

A) the potential conflict of interests between the MNC's managers and shareholders is avoided.
B) the potential conflict of interests between the MNC's majority shareholders and minority shareholders is avoided.
C) the potential conflict of interests between the MNC's existing creditors is avoided.
D) the potential conflict of interests between the MNC's managers and creditors is avoided.

Question 20

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 21

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) new common equity
D) none of the above

Question 22

Normally,an MNC will issue stock in all of the countries where it does business.

Question 23

When assuming that financial markets are segments,it is acceptable to use the U.S.market when measuring a U.S.-based MNC's project's beta.

Question 24

Assume the following information for Pexi Co.,a U.S.-based MNC that is considering obtaining 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 25

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 26

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

MNC 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 MNC stock

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

Question 28

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 29

The ____________ the cost of capital,the ___________ will be a project's net present value for a project with a given set of expected cash flows.

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

Question 30

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 31

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

A) exchange rate risk.
B) country risk.
C) political risk.
D) size.

Question 32

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 33

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 34

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 35

Assume the following information for Pexi Co.,a U.S.-based MNC that is considering obtaining 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 debt

A) 7.0%.
B) 8.0%.
C) 6.3%.
D) 4.9%.

Question 36

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 37

When an MNC is considering financing a portion of a foreign project within the foreign country,the best method to account for a foreign project's risk is to:

A) derive net present values based on the WACC.
B) adjust the weighted average cost of capital for the risk differential.
C) derive the net present value of the equity investment.
D) none of the above

Question 38

Which of the following is not a reason 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 risk premium.
D) differences in demographics.

Question 39

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 40

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 41

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 42

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

Question 43

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

Question 44

Although an MNC can adjust either the discount rate or the cash flows to account for a project's risk,there is no perfect formula to adjust for a project's unique risk.

Question 45

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 46

In the United States,government rescues are not as common as in other countries,such as the United Kingdom.Therefore,the risk premium on a given level of debt would be higher for U.S.firms than for firms of the United Kingdom,everything else being equal.

Question 47

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 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 49

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

Question 50

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.