Question 1

When evaluating new investment alternatives, the multinational corporation should use a discount rate that reflects the systematic risk of other assets in that country.

Accepted Answer

Use an asset-specific discount rate that reflects the risk of the proposed investment.

Question 2

A higher cost of capital on foreign investment could arise if a foreign government requires that at least a part of the foreign investment be financed locally.

Accepted Answer

If a foreign government requires that a portion of the foreign investment be financed locally, this could increase the cost of capital as the foreign investor may have to pay higher interest rates or face other barriers to accessing funding in the local market. This can increase the overall cost of the investment and make it less attractive.

Question 3

If financial markets are perfect, then the value of an asset is determined by the value of expected future investment cash flows and not by the way that it is financed.

Accepted Answer

In perfect financial markets, the value of an asset is based solely on the expected future cash flows it is expected to generate and not on how it is financed. The method of financing does not impact the value of the asset.

Question 4

If investors are restricted from some markets by capital flow barriers, then the multinational corporation with access to these markets can provide indirect diversification benefits to investors.

Accepted Answer

If investors are unable to invest directly in some markets due to capital flow restrictions, investing in multinational corporations with access to those markets can provide indirect exposure to those markets and diversification benefits.

Question 5

The goal of financial policy is to minimize the firm's overall cost of capital, given the firm's assets.

Accepted Answer

The goal of financial policy is to minimize the firm's overall cost of capital, which ultimately leads to maximizing the firm's value. This can be achieved by making decisions related to financing, investment, and dividend policies. The ultimate aim is to achieve an optimal capital structure that balances the cost of debt and equity financing with the potential benefits of financial leverage.

Question 6

According to the weighted average cost of capital approach to project valuation, operating cash flows are discounted at the required return of levered equity capital.

Accepted Answer

After-tax operating cash flows to debt and equity are discounted at a weighted average of after-tax required returns on debt and equity capital.

Question 7

In integrated financial markets, nominal rates of return on equivalent assets are equal.

Accepted Answer

In integrated markets, real after-tax required returns on equivalent assets are equal.

Question 8

In a perfect and integrated financial market, investors can reduce or even eliminate the currency risk exposures of their portfolios through their own portfolio hedging and diversification strategies.

Accepted Answer

In a perfect and integrated financial market, investors have access to a wide range of financial instruments and assets denominated in different currencies, allowing them to diversify their portfolios and reduce their exposure to currency risk through various hedging techniques. This is because currency risk arises from the fluctuation in exchange rates between two currencies, and in an integrated market, there should be no restrictions on exchange or convertibility of currencies, making it easier for investors to manage their currency exposures.

Question 9

The weighted average cost of capital cannot be calculated for a single segment in a multi-segment firm when the segments have different systematic risks.

Accepted Answer

When applied to a single division in a multi-segment firm, the WACC should reflect the after-tax required returns on the debt and equity supported by that division weighted by the division's target debt- and equity-to-value ratios.

Question 10

Capital structure refers to the relative proportion of monetary and real assets in the firm.

Accepted Answer

Capital structure refers to the proportions and forms of long-term debt and equity capital used to finance the assets of the firm.

Question 11

The total operating risk of a foreign investment could be greater than the risk of a similar domestic investment, and yet the investment could have a lower required return than a similar domestic investment.

Accepted Answer

This is because the foreign investment may provide additional benefits such as diversification of currency and political risk, tax benefits, or potential higher growth opportunities. These factors could lead to a lower required return for the foreign investment despite facing higher operating risks.

Question 12

If goods and financial markets are segmented across national borders but are otherwise efficient, then multinational corporations can reduce their cost of capital through foreign direct investment or through financing from foreign sources or both.

Accepted Answer

Multinational corporations can take advantage of differences in interest rates and market conditions across borders to source cheaper financing or invest in projects with lower costs of capital. This allows them to increase their profitability and competitiveness in segmented markets.

Question 13

In the real world, hedging can increase the firm's expected cash flows by reducing expected taxes, bankruptcy costs, and agency costs.

Accepted Answer

Hedging can reduce a firm's expected taxes by reducing the volatility of its earnings, which can reduce the impact of progressive tax rates. Hedging can also reduce expected bankruptcy costs by reducing the likelihood of financial distress, and can reduce agency costs by aligning the interests of managers and shareholders.

Question 14

If financial markets are integrated and systematic risk is to be measured against a market portfolio, then the appropriate choice of a market portfolio is the domestic market index.

Accepted Answer

The world market index is the appropriate market portfolio.

Question 15

Foreign political risks increase the variability of outcomes on foreign investment projects.

Accepted Answer

Foreign political risks such as changes in government policies, instability, or conflict can lead to changes in local regulations, unpredictable business environments, and economic instability, which increases the variability of outcomes and potential negative impacts on foreign investment projects.

Question 16

In perfect and integrated financial markets, multinational corporations are able to achieve diversification benefits that cannot be replicated by individual investors or portfolio managers.

Accepted Answer

Investors can already diversify for themselves in perfect, integrated financial markets.

Question 17

On balance, market segmentation hurts the multinational corporation more than the domestic corporation.

Accepted Answer

The multinational corporation may be able to gain access to new investments or financing at more favorable rates than are available domestically.

Question 18

A consequence of the perfect market assumptions is that a firm's cost of capital is independent of its capital structure.

Accepted Answer

Given the firm's investments, financial structure determines the firm's cost of capital.

Question 19

If financial markets are perfect and there are no taxes, then corporate financial policy is vitally important to the firm's stakeholders.

Accepted Answer

If financial markets are perfect, then corporate financial policy is irrelevant.

Question 20

The total risk of a foreign investment is likely to be greater than similar domestic investments.

Accepted Answer

Foreign investments introduce additional risks such as currency exchange rate fluctuations, political instability, and different legal systems. These factors increase the overall risk of the investment compared to similar investments made in the domestic market.

Quiz 14: Multinational Capital Structure and Cost of Capital