Deck 14: The Cost of Capital for Foreign Investment

Question 1

One of the key issues in estimating foreign project betas is to find firms that are publicly traded that share _______ risk characteristics when compared to the project.

A) different
B) somewhat different
C) uncorrelated
D) similar

Answer 1

D

Question 2

LDCs have greater ______ risk but offer the higher probability of diversification benefits.

A) economic
B) translation
C) political
D) operating

Answer 2

C

Question 3

The cost of capital for a project in Australia should theoretically

A) equal the parent's weighted average cost of capital
B) equal the required return for a similar investment in the U.S.
C) equal the minimum rate of return necessary to induce investors to buy or hold the firm's stock
D) depend on the riskiness of the project itself

Answer 3

D

Question 4

When computing the weighted average cost of capital, the weighting should be proportional based on the _______ rather than the _______ value of the firm.

A) book, market
B) hypothetical, book
C) market, analyst's
D) market, book

Question 5

The cost of capital for a project in Spain should

A) equal the parent's weighted average cost of capital
B) equal the required return for a similar investment in the U.S.
C) equal the minimum rate of return necessary to induce investors to buy or hold the firm's stock
D) be a function of the riskiness of the project itself

Question 6

There is a high probability that the cost of capital for a foreign project will

A) exceed the cost of capital for a comparable domestic project
B) be no greater than the cost of capital for a comparable domestic project
C) be the same as the cost of capital for a comparable domestic project
D) exceed the investor's required rate of return

Question 7

According to modern capital market theory an equilibrium relationship exists between an asset's required return and its associated risk, which can be represented by the _______ model.

A) risk-return tradeoff
B) capital asset pricing
C) purchasing parity
D) interest rate parity

Question 8

When identifying proxy firms for a foreign project analysis, it is desirable to use _______ firms.

A) local
B) home country
C) emerging market
D) developed economy

Question 9

The cost of capital for a project depends on

A) the correlation between returns on the project and returns on a domestic market index
B) the correlation between returns on the project and returns on a globally?diversified portfolio
C) the correlation between returns on the project and returns on the firm's other activities
D) whether the price of risk is set on a domestic or worldwide basis

Question 10

The rate(s) at which investors capitalize the returns on foreign projects depends on all of the following EXCEPT

A) whether shareholders are internationally diversified
B) the relative costs of international diversification for the MNC and for individual investors
C) the extent to which domestic systematic risk is unsystematic from a global standpoint
D) the correlation between equity returns on different markets

Question 11

Systematic risk is that portion of return variability that

A) can be eliminated through diversification
B) cannot be eliminated unless fixed income securities are added to the portfolio
C) can be reduced through diversification but not eliminated
D) cannot be eliminated through diversification

Question 12

Suppose that a foreign project has a beta of the risk?free return is and the required return on the market is estimated at 18%. Then the cost of capital for the project is

A) 17.21%
B) 21.37%
C) 19.04%
D) 20.03%

Question 13

To avoid the awkward process of transferring the cost of capital going from the parent to the subsidiary, it is advisable to use the _______ rate.

A) prime market interest
B) all-equity discount
C) all-debt discount
D) both the equity and debt discount

Question 14

What is the outcome when the cost of equity capital is combined with after-tax cost of debt?

A) all-equity beta
B) cost of capital
C) weighted average cost of capital
D) target capital structure

Question 15

The ________ for a given investment is the minimum risk-adjusted return required by the shareholders of the firm for undertaking that investment.

A) cost of equity capital
B) systematic risk
C) all-equity beta
D) weighted average cost of capital

Question 16

Suppose that a foreign project has a beta of 0.85, the risk?free return is 12%, and the required return on the market is estimated at 19%. Then the cost of capital for the project is

A) 16.15%
B) 17.95%
C) 19%
D) 21.23%

Question 17

One function of the cost of capital is to _______ for the firm.

A) determine the debt to equity ratio
B) value future cash flows
C) determine the current ratio
D) determine the current lending rate

Question 18

The cost of capital for a General Foods Jell-O plant in Venezuela is likely to be

A) lower than for a comparable plant in the U.S., because its systematic risk is probably lower
B) higher than for a comparable U.S. plant because of the added risks associated with the unstable economic and political environment
C) about the same because the systematic risk is likely to be very similar
D) greatly impacted by the change in political parties in neighboring Colombia

Question 19

Which project is likely to entail the least systematic risk?

A) a Ford plant in Brazil producing engines for export to the U.S.
B) a Coca Cola plant in Brazil selling locally
C) a machine tool plant in Japan
D) a computer disk drive plant in Germany

Question 20

Suppose that a foreign project has a beta of the risk?free return is 8% and the required return on the market is estimated at 17%. Then cost of capital for the project is

A) 24.2%
B) 19.3%
C) 18.1%
D) 15.4%

Question 21

The systematic risk of a project depends on

A) the correlation between returns on the project and returns on the world market portfolio
B) the correlation between returns on the project and returns on a domestically?diversified portfolio
C) whether investors hold a domestically? or globally?diversified portfolio
D) the various political and economic risks the project is subject to

Question 22

Suppose the euro is expected to depreciate against the dollar by 2% annually and the 10-year franc interest rate is 11%. What is the after-tax expected dollar cost of issuing a 10-year franc bond if the French corporate tax rate is 40%?

A) 5.93%
B) 7.61%
C) 4.47%
D) 6.60%

Question 23

A U.S. company that has issued euro bonds could hedge at least part of the exchange risk associated with those bonds by

A) invoicing its exports to Germany in euro
B) invoicing its imports from Germany in euro
C) invoicing its exports to Germany in dollars
D) invoicing its imports from Germany in dollars

Question 24

Assume an average dividend payout rate of 100% for both U.S. and Japanese companies. Suppose the average P/E ratio for Japanese firms is 38 and 16 for U.S. firms. Based on the dividend growth model, in order for Japanese and U.S. companies to have the same average cost of equity capital, how much higher would the Japanese annual earnings growth rate have to be?

A) 7.24%
B) 6.31%
C) 5.83%
D) 8.39%

Question 25

Suppose that a foreign project has a beta of the risk?free return is 13% and the required return on the market is estimated at 21%.Then the cost of capital for the project is

A) 24.2%
B) 22.2%
C) 19.3%
D) 15.4%

Question 26

The principal advantage(s) of investing in foreign affiliates in the form of debt instead of equity is to

A) reduce taxes
B) reduce the impact of currency controls
C) both a and b
D) there are no advantages

Question 27

Assume an average dividend payout rate of 60% for U.S. companies and 35% for Japanese companies. Suppose the average P/E ratio for Japanese firms is 38 and 16 for U.S. firms. Based on the dividend growth model, in order for Japanese companies to have the same 12% average cost of equity capital estimated for U.S. companies, how much higher would the Japanese annual earnings growth rate have to be?

A) 8.74%
B) 3.45%
C) 7.60%
D) 2.83%

Question 28

Suppose the euro is expected to appreciate by 4% annually against the dollar. If a company can borrow dollars at what is the highest interest rate it should be willing to pay to borrow euro, assuming it is trying to minimize its expected financing cost?

A) 5.1%
B) 4.3%
C) 7.2%
D) 8.9%

Question 29

Consider a project that costs $1 million today but yields no returns for several years. Once the project becomes productive, it yields $250,000 annually forever. Suppose two firms are examining this project, a Japanese firm with a cost of capital of 7% and a U.S. firm with a cost of capital of 13%. Approximately how many more years than the U.S. firm would the Japanese firm be willing to wait until the project starts generating cash?

A) 14 years
B) 5 years
C) 24 years
D) 3 years

Question 30

Capital structures of foreign affiliates should

A) conform to the standards set by local companies
B) vary in order to take advantage of opportunities to reduce overall risk and financing costs
C) be very similar to the parent's capital structure because this is what determines the firm's risk profile
D) conform to the standards established by other foreign units

Question 31

The existence of offshore finance subsidiaries can be attributed primarily to

A) the past practice of the U.S. IRS to impose withholding taxes on dividends and interest received by foreign investors
B) the desire by MNCs to centralize their financial decision making
C) capital controls by various foreign countries
D) capital flight from the parent country