Deck 12: The Global Cost and Availability of Capital

Question 1

Systematic risk

A) is the standard deviation of a securities returns.
B) is measured with beta.
C) is measured with standard deviation.
D) none of the above.

Answer 1

is measured with beta.

Question 2

The capital asset pricing model (CAPM) is an approach

A) to determine the price of equity capital.
B) used by marketers to determine the price of saleable product.
C) can be applied only to domestic markets.
D) none of the above.

Answer 2

to determine the price of equity capital.

Question 3

If a company fails to accurately predict it's cost of equity, then

A) the firm's WACC will also be inaccurate.
B) the firm may not be using the proper interest rate to estimate NPV.
C) the firm my incorrectly accept or reject projects based on decisions made using the cost of capital computed with an incorrect cost of equity.
D) all of the above are true.

Answer 3

all of the above are true.

Question 4

LipTea Incorporated purchases raw materials and has processing plants around the world. The firm has an average pre-tax cost of debt of 8%, an average tax rate of 40%, and an international equity beta of 1.2. The risk-free rate of return is anticipated to be 4% and the return to the international market portfolio to be 12%. If the firm finances 40% with debt and 60% with equity, what is the after-tax WACC?

A) 10.08%
B) 12.96%
C) 11.36%
D) 10.50%

Question 5

LipTea Incorporated purchases raw materials and has processing plants around the world. They also have an international market for their product. Because of their presence in so many countries LipTea has the ability to raise capital around the world in several different markets. LipTea is truly an MNE. If the firm has an average pre-tax cost of debt of 8%, a cost of equity of 13%, and an average tax rate of 40%, what is their after-tax cost of debt?

A) 3.2%
B) 8.0%
C) 4.8%
D) 10.5%

Question 6

Which of the following is generally unnecessary in measuring the cost of debt?

A) a forecast of future interest rates
B) the proportions of the various classes of debt a firm proposes to use
C) the corporate income tax rate
D) All of the above are necessary for measuring the cost of debt.

Question 7

LipTea Incorporated purchases raw materials and has processing plants around the world. The standard deviation of the firm's equity returns is 1.2 times as great as the market's standard deviation of returns. If the correlation of LipTea's returns with the market's is 0.80, what is the systematic risk of the firm?

A) 1.50
B) 1.20
C) 0.96
D) There is not enough information to answer this question.

Question 8

Other things equal, an increase in the firm's tax rate will increase the WACC for a firm that has both debt and equity financing.

Question 9

Johnson Fuel Systems has a weighted average cost of capital of 7.35%. Estimate Johnson's cost of equity given the following information: The firm's effective tax rate is 25%, they have an equal mix of debt and equity, the required return on the market portfolio is 9%, Johnson has a before-tax cost of debt of 6%, and the risk-free rate of return is 3%.

A) 2.25%
B) 5.10%
C) 9.00%
D) 10.20%

Question 10

Ready Supply Co. has a cost of debt of 8%. The risk-free rate of interest is 3% and the expected return on the market portfolio is 10%. If the firm has a beta of 0.90 and an effective tax rate of 30% with a capital structure that is 40% debt and 60% equity, what is the firm's weighted average cost of capital?

A) 7.82%
B) 9.30%
C) 5.60%
D) 8.00%

Question 11

LipTea Incorporated purchases raw materials and has processing plants around the world. The firm finances 30% of its assets with debt and 70% with equity, has a 30% average tax rate, and can issue bonds at a pre-tax rate of 7%. Their standard deviation of returns is roughly 1.50 times as great as the market's returns, and has a correlation with the market of 0.45. If the risk-free rate of return is 5% and the expected return on the international market portfolio is 14%, what is the firm's WACC?

A) 7.75%
B) 8.38%
C) 12.24%
D) There is not enough information to answer this question.

Question 12

Which of the following is NOT a key variable in the weighted average cost of capital (WACC) equation?

A) the market value of equity
B) the market value of debt
C) the risk-free rate of return
D) the marginal tax rate

Question 13

In the firm's WACC estimate, cost of debt is

A) calculated using CAPM.
B) weighted average of the principles of different debt components.
C) adjusted with the effective tax rate because interest payments are deductible item.
D) equivalent only to the interest on firm's market debt securities.

Question 14

Which of the following is NOT a key variable in the weighted average cost of capital (WACC) equation?

A) the before-tax cost of debt
B) the risk-adjusted cost of equity
C) the beta of the market portfolio
D) the total market value of the firm's securities

Question 15

________ risk is a function of the variability of expected returns of the firm's stock relative to the market index and the measure of correlation between the expected returns of the firm and the market.

A) Systematic
B) Unsystematic
C) Total
D) Diversifiable

Question 16

The WACC is usually used as the risk-adjusted required rate of return for new projects that are of the same average risk as the firm's existing projects.

Question 17

Which of the following is NOT a key variable in the equation for the capital asset pricing model?

A) the risk-free rate of interest
B) the expected rate of return on the market portfolio
C) the marginal tax rate
D) All are important components of the CAPM.

Question 18

Segmented national capital markets are limiting firm's competitive advantage in sourcing capital because

A) there is liquid demand for all securities.
B) the yield on the debt securities are lower than in other mature capital markets.
C) FX risk is eliminated with different industry segmentation.
D) the cost and availability of capital can be constrained by excessive regulatory controls and perceived political risk.

Question 19

The weighted average cost of capital (WACC) is

A) the required rate of return for all of a firm's capital investment projects.
B) the required rate of return for a firm's average risk projects.
C) not applicable for use by MNE.
D) equal to 13%.

Question 20

The after-tax cost of debt is found by

A) dividing the before-tax cost of debt by (1 - the corporate tax rate).
B) subtracting (1 - the corporate tax rate) from the before-tax cost of debt.
C) multiplying the before-tax cost of debt by (1 - the corporate tax rate).
D) subtracting the corporate tax rate from the before-tax cost of debt.

Question 21

Capital market imperfections leading to financial market segmentation include

A) asymmetric information between domestic and foreign-based investors.
B) high securities transaction costs.
C) foreign exchange risks.
D) All of the above.

Question 22

Other things equal, a firm that must obtain its long-term debt and equity in a highly illiquid domestic securities market will probably have a

A) relatively low cost of capital.
B) relatively high cost of capital.
C) relatively average cost of capital.
D) cost of capital that we cannot estimate from this question.

Question 23

If a firm lies within a country with ________ or ________ domestic capital markets, it can achieve lower global cost and greater availability of capital with a properly designed and implemented strategy to participate in international capital markets.

A) liquid; segmented
B) liquid; large
C) illiquid; segmented
D) large; illiquid

Question 24

International Portfolio constructed of diversified international securities

A) is adding foreign exchange risk to the portfolio and increasing the total risk because the assets are less than perfectly correlated.
B) has total return identical to the return of the domestic portfolio.
C) is less complex than the domestic portfolio because of less portfolio composition and diversification possibilities.
D) None of the above

Question 25

In general the geometric mean will be ________ the arithmetic mean for a series of returns.

A) less than
B) greater than
C) equal to
D) greater than or equal to

Question 26

One of the distinct features of international equity markets is that over the last 100 or so years, the average market risk premium is almost identical across major industrial countries.

Question 27

Relatively high costs of capital are more likely to occur in

A) highly illiquid domestic securities markets.
B) highly liquid domestic securities markets.
C) unsegmented domestic securities markets.
D) none of the above

Question 28

Which of the following is NOT a portfolio diversification technique used by portfolio managers?

A) diversify by type of security
B) diversify by the size of capitalization of the securities held
C) diversify by country
D) All of the above are diversification techniques.

Question 29

A national securities market is segmented if the required rate of return on securities in that market differs from comparable securities traded in other, unsegmented markets.

Question 30

The beginning share price for a security over a three-year period was $50. Subsequent year-end prices were $62, $58 and $64. The arithmetic average annual rate of return and the geometric average annual rate of return for this stock were

A) 9.30% and 8.78%, respectively.
B) 9.30% and 7.89%, respectively.
C) 9.30% and 7.03%, respectively.
D) 9.30% and 6.37%, respectively.

Question 31

The difference between the expected (or required) return for the market portfolio and the risk-free rate of return is referred to as

A) beta.
B) the geometric mean.
C) the market risk premium.
D) the arithmetic mean.

Question 32

Reasons that firms may find themselves with relatively high costs of capital include which of the following?

A) The firms reside in emerging countries with undeveloped capital markets.
B) The firms are too small to easily gain access to their own national securities market.
C) The firms are family owned and they choose not to access public markets and lose control of the firm.
D) All of the above.

Question 33

If all capital markets are fully integrated, securities of comparable expected return and risk should have the same required rate of return in each national market after adjusting for

A) time of day and language requirements.
B) political risk and time lags.
C) foreign exchange risk and political risk.
D) foreign exchange risk and the spot rate.

Question 34

Which of the following is NOT a contributing factor to the segmentation of capital markets?

A) excessive regulatory control
B) perceived political risk
C) anticipated foreign exchange risk
D) All of the above are contributing factors.

Question 35

Capital market imperfections leading to financial market segmentation include

A) political risks.
B) corporate governance differences.
C) regulatory barriers.
D) All of the above.

Question 36

A firm whose equity has a beta of 1.0

A) has greater systematic risk than the market portfolio.
B) stands little chance of surviving in the international financial market place.
C) has less systematic risk than the market portfolio.
D) None of the above is true.

Question 37

Capital market segmentation is a financial market imperfection caused mainly by

A) government constraints.
B) institutional practices.
C) investor perceptions.
D) all of the above

Question 38

If a company fails to accurately predict it's cost of equity, then

A) the firm's WACC will also be inaccurate.
B) the firm may not be using the proper interest rate to estimate NPV.
C) the firm my incorrectly accept or reject projects based on decisions made using the cost of capital computed with an incorrect cost of equity.
D) all of the above are true.

Question 39

Which of the following is NOT a contributing factor to the segmentation of capital markets?

A) lack of transparency
B) asymmetric availability of information
C) lack of proper reporting of insider trading
D) All of the above are contributing factors.

Question 40

If a firm's expected returns are more volatile than the expected return for the market portfolio, it will have a beta less than 1.0.

Question 41

The optimal financial structure of multinational firms could differ from that of domestic firms because of

A) political pressures on the host country.
B) the greater availability of capital to multinational firms.
C) the ability of multinational firms to diversify their cash flows internationally.
D) all of the above.

Question 42

Empirical studies indicate that MNEs have higher costs of capital than purely domestic firms. This could be due to higher levels of

A) political risk.
B) exchange rate risk.
C) agency costs.
D) all of the above

Question 43

The opportunity set of projects is typically smaller for MNEs than for purely domestic firms because international markets are typically specialized niches.

Question 44

Market imperfections do not necessarily imply that national securities markets are inefficient.

Question 45

In theory MNE should be able to support higher debt ratios and have lower associated costs.

Question 46

Several years ago the Danish equity market prohibited ownership of foreign securities thus few institutional analysts outside of Denmark bothered to follow Danish equity securities. This particular fact led to market segmentation due to

A) taxation.
B) political risk.
C) asymmetric information.
D) financial risk.

Question 47

Empirical studies have shown that MNE's

A) mangers tend to limit firm's capital budget to what can be financed with free cash flows.
B) have lower debt/capital ratio than domestic counterparts.
C) are exposed to higher level of political risk, FX risk and higher agency costs.
D) all of the above

Question 48

Which of the following does NOT constitute a benefit to the investor of diversifying internationally?

A) the relatively low degree of correlation between the world's stock markets
B) the increase in the expected return from an internationally diversified investment
C) a lower total level of nondiversifiable risk
D) All of the above are benefits of international diversification.

Question 49

Domestic firms rely much more heavily on short and intermediate debt, which lie at the low cost end of the yield curve, than do MNEs.

Question 50

Which of the following statements is NOT true regarding MNEs when compared to purely domestic firms?

A) MNEs tend to rely more on short and intermediate term debt.
B) MNEs have greater foreign exchange risk.
C) MNEs have greater costs of asymmetric information.
D) MNEs have higher agency costs.

Question 51

The international availability of capital to MNEs

A) allows the firm to avoid income taxes.
B) allows the firm to shift tax payments to other counties.
C) allows the firm to lower their cost of equity, relative to domestic firms.
D) none of the above.

Question 52

A MNEs marginal cost of capital is constant for considerable ranges in its capital budget, but this statement cannot be made for most domestic firms.

Question 53

Internationally diversified portfolios often have a lower rate of return and almost always have a higher level of portfolio risk than their domestic counterparts.

Question 54

Because of the international diversification of cash flows, the risk of bankruptcy for MNEs is significantly lower than that for purely domestic firms.

Question 55

Your authors identify three firm and market characteristics that, in part, determine differences in a firm's cost of capital in a purely domestic market versus a global capital market. What are these three market characteristics and how do they help differentiate a firm's cost of capital?

Question 56

According to your authors, diversifying cash flows internationally may help MNEs reduce the variability of cash flows because

A) of a lack of competition among international firms.
B) of an offset to cash flow variability caused by exchange rate variability.
C) returns are not perfectly correlated between countries.
D) none of the above.

Question 57

Theoretically, most MNEs should be in a position to support higher ________ than their domestic counterparts because their cash flows are diversified internationally.

A) equity ratios
B) debt ratios
C) temperatures
D) none of the above

Question 58

Empirical research has found that systematic risk for MNEs is greater than that for their domestic counterparts. This could be due to

A) the fact that the increase in the correlation of returns between the market and the firm is less than the increase in the standard deviation of returns of the firm.
B) the fact that the decrease in the correlation of returns between the market and the firm is greater than the increase in the standard deviation of returns of the firm.
C) the reduction in the correlation of returns between the firm and the market is less than the increase in the variability of returns caused by factors such as asymmetric information, foreign exchange risk, and the like.
D) none of the above. Systematic risk is less for MNEs than for their domestic counterparts.

Question 59

Empirical studies show that neither mature domestic firms nor MNEs are typically willing to assume the higher agency costs or bankruptcy risk associated with higher MCCs and capital budgets.

Question 60

Until 1981 Danish equity securities were taxed at a capital gains rate of 50% for securities held for over two years, and at a speculative gains rate of 75% for securities held for under two years. This led to market segmentation caused by

A) taxation.
B) political risk.
C) asymmetric information.
D) financial risk.

Question 61

What are the components of the weighted average cost of capital (WACC) and how do they differ for an MNE compared to a purely domestic firm?

Question 62

What do theory and empirical evidence say about capital structure and the cost of capital for MNEs versus their domestic counterparts?

Question 63

What motivates portfolio investors to purchase and hold foreign securities in their portfolio?