Deck 13: The Global Cost and Availability of Capital

Question 1

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.

Answer 1

multiplying the before-tax cost of debt by (1 - the corporate tax rate).

Question 2

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)insider trading
D)All of the above are contributing factors.

Answer 2

All of the above are contributing factors.

Question 3

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

Answer 3

illiquid; segmented

Question 4

________ 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 5

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 may 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 6

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 7

Reasons that firms may find themselves with relatively high costs of capital include:

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 8

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 9

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)that can be applied only to domestic markets.
D)none of the above

Question 10

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 11

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 12

Which of the following statements is NOT true regarding beta?

A)Beta will have a value of less than 1.0 if the firm's returns are less volatile than the market.
B)Beta will have a value of greater than 1.0 if the firm's returns are more volatile than the market.
C)Beta will have a value of equal to 1.0 if the firm's returns are of equal volatility to the market.
D)All of the statements above are true.

Question 13

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 was:

A)9.30% and 8.58% respectively.
B)9.30% and 7.89% respectively.
C)9.30% and 7.03% respectively.
D)9.30% and 6.37% respectively.

Question 14

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 15

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 16

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 17

Which of the following will NOT affect a firm's beta?

A)the choice of the market portfolio against which to compare the variability of a firm's returns
B)the choice of the risk-free security
C)the choice of the time period used to calculate the firm's beta
D)None of the above, because each of them affects the calculation of a firm's beta.

Question 18

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 19

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 20

Systematic risk:

A)is the standard deviation of a security's return.
B)is measured with beta.
C)is measured with standard deviation.
D)none of the above

Question 21

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 22

International CAPM (ICAPM)assumes that there is a global market in which the firm's equity trades, and estimates of the firm's beta, and the market risk premium, must then reflect this global portfolio.

Question 23

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 24

Firms acquire debt in either the form of loans from commercial banks, or by selling new common stock.

Question 25

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 26

The geometric mean will, in all but a few extreme circumstances, yield a larger return than the arithmetic mean return.

Question 27

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 28

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 29

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 30

When estimating an average corporate after-tax cost of capital, the component cost of equity is multiplied by (1-t)to allow for the tax-deductibility of dividend payments.

Question 31

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 32

The primary goal of both domestic and international portfolio managers is:

A)to maximize return for a given level of risk, or to minimize risk for a given level of return.
B)to minimize the number of unique securities held in their portfolio.
C)to maximize their WACC.
D)all of the above

Question 33

One of the elegant beauties 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 34

Use of the International CAPM (ICAPM)assures that the WACC will be lower than if a purely domestic market portfolio had been used in the estimation of the cost of equity.

Question 35

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 36

The CAPM has now become very widely accepted in global business as the preferred method of calculating the cost of equity for a firm. As a result of this, there is now little debate over what numerical values should be used in its application.

Question 37

The authors refer to companies that have access to a ________ as MNEs, and firms without such access are identified as ________.

A)global cost and availability of capital; domestic firms.
B)large domestic capital market; geographically challenged.
C)world financial markets; antiquated.
D)none of the above

Question 38

A global portfolio is an index of all the securities in the world, whereas a world portfolio represents those securities actually available to an investor.

Question 39

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 40

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 41

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 42

Despite the theoretical elegance of this hypothesis, empirical studies have come to the opposite conclusion.Despite the favorable effect of international diversification of cash flows, bankruptcy risk was only about the same for MNEs as for domestic firms. However, MNEs faced higher costs for each of the following EXCEPT:

A)agency costs.
B)political risk.
C)asymmetric information.
D)In fact, each of these costs were higher for the MNE than for the domestic firm.

Question 43

Empirical tests of market efficiency fail to show that most major national markets are reasonably efficient.

Question 44

Surprisingly, empirical studies find that MNEs have a higher level of systematic risk than their domestic counterparts.

Question 45

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

Question 46

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

Question 47

Capital market segmentation is a financial market imperfection caused mainly by government constraints, institutional practices, and investor perceptions.

Question 48

Empirical studies indicate that MNEs have a lower debt/capital ratio than domestic counterparts, indicating that MNEs have a lower cost of capital.

Question 49

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 50

Since the 1980s and 1990s, segmentation in global financial markets has been reduced. As a result of this, the correlation among securities markets has increased, thereby reducing, but not eliminating, the benefits of international portfolio diversification.

Question 51

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

Question 52

The optimal capital budget:

A)occurs where the marginal cost of capital equals the marginal rate of return of the opportunity set of projects.
B)is typically larger for purely domestic firms than for MNEs.
C)is an illusion found only in international finance textbooks.
D)none of the above

Question 53

The MNE can ________ its ________ by gaining access to markets that are more liquid and/or less segmented than its own.

A)increase; MCC.
B)decrease; MCC.
C)maintain; MRR.
D)none of the above

Question 54

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 55

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 56

Empirical studies indicate that WACC for an MNE is higher than for their domestic competitors. Reasons cited for this increased cost include all of the following EXCEPT:

A)agency costs.
B)foreign exchange risk.
C)political risk.
D)All of the above are cited as reasons for an MNE's increased WACC.

Question 57

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 58

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 59

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.