Question 1

The capital asset pricing model (CAPM) suggests that the required return on a firm's stock is a positive function of the risk-free rate of interest and the market rate of return and a negative function of the stock's beta.

Accepted Answer

The CAPM suggests that the required return on a firm's stock is a positive function of the risk-free rate of interest, the stock's beta, and the market rate of return minus the risk-free rate of interest. The stock's beta measures the stock's volatility relative to the market, and a higher beta increases the required return, not decreases it.

Question 2

If a parent MNC backs the debt of a foreign subsidiary, the borrowing capacity of the parent might be reduced because creditors may not be willing to provide as many funds to the parent if those funds may possibly be needed to rescue the subsidiary.

Accepted Answer

When a parent MNC backs the debt of a foreign subsidiary, it becomes liable to pay for the subsidiary's debts in case of default. This increases the parent's overall risk exposure and decreases its creditworthiness. Creditors may perceive the parent as more risky and therefore may not be willing to provide as many funds to the parent, as these funds may potentially be needed to rescue the subsidiary. This, in turn, can reduce the borrowing capacity of the parent.

Question 3

An MNC's cost of equity is unrelated to the local risk-free rate.

Accepted Answer

The cost of equity for an MNC is related to the local risk-free rate as it is a key component used in calculating the cost of equity using the capital asset pricing model (CAPM).

Question 4

When assuming that investors in the United States are most concerned with their exposure to the U.S. stock market, it is acceptable to use the U.S. market when measuring a U.S.-based MNC's project's beta.

Accepted Answer

Since the investors in the United States are most concerned with their exposure to the U.S. stock market, it is reasonable to use the U.S. market when measuring a U.S.-based MNC's project's beta. However, this assumption may not hold true for multinational corporations with significant operations in other countries or for investors with a more diversified portfolio.

Question 5

The cost of an MNC's capital can be measured as the cost of its debt plus the cost of its equity, with appropriate weights applied to reflect the percentages of debt and equity.

Accepted Answer

This statement is true. The cost of capital of an MNC (multi-national corporation) can be determined by calculating the weighted average cost of its debt and equity. The weights given to debt and equity reflect the proportions of each that are used to finance the MNC's operations.

Question 6

There is an advantage to using equity rather than debt financing because dividend payments are tax deductible.

Accepted Answer

Dividend payments are not tax deductible, regardless of whether the company uses equity or debt financing.

Question 7

It is always advantageous to use foreign debt to finance a foreign project, particularly in developing countries.

Accepted Answer

Using foreign debt to finance a project, especially in developing countries, can expose the project to currency and repayment risks, and it may not always be the most advantageous option due to potential fluctuations in exchange rates and the economic stability of the country.

Question 8

When MNCs pursue international projects that have a high potential for return, but also increase their risk, this increases the return to the bondholders that provided credit to the MNCs.

Accepted Answer

When MNCs pursue high-risk international projects, the increased risk primarily benefits shareholders if the projects succeed, as they have a residual claim on profits after all debts are paid. Bondholders have a fixed interest rate return, and their returns do not directly increase with the firm's riskier ventures.

Question 9

In the United States, government rescues of failing firms are not as common as they are in some other countries. Assuming that this is expected to continue in the future, the risk premium on a given level of debt would be higher for U.S. firms than for firms in countries where government rescues are more common, everything else being equal.

Accepted Answer

The risk premium on a given level of debt would be higher for U.S. firms than for firms in countries where government rescues are more common because there is less likelihood of government intervention to save failing firms in the U.S. compared to those other countries.

Question 10

Since the cost of funds can vary among markets, an MNC's access to the international capital markets may allow it to attract funds at a lower cost than that paid by domestic firms.

Accepted Answer

This statement is correct as international capital markets offer a wider range of funding options and competition among lenders, which can result in MNCs being able to access funds at a lower cost than domestic firms.

Question 11

Normally, each subsidiary of an MNC will issue its own stock where it does business.

Accepted Answer

Each subsidiary of an MNC is not required to issue its own stock where it does business. The MNC as a whole issues stock and the ownership of the subsidiary is reflected in the ownership of the MNC's stock.

Question 12

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.

Accepted Answer

This statement is false. Generally, the cost of debt in less developed countries is higher due to their perceived higher risk for lenders. Industrialized countries usually have lower borrowing costs due to their stable economies and high creditworthiness.

Question 13

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.

Accepted Answer

Yes, country differences can cause the cost of capital to vary across countries by affecting the risk-free interest rate and risk premiums. For example, a country with higher perceived risks (such as political instability or weak economic conditions) may have a higher risk premium, which would increase the cost of capital for investors in that country. Additionally, differences in inflation rates and exchange rates can also impact the cost of capital.

Question 14

An MNC with stable cash flows can probably handle more debt than an MNC with erratic cash flows.

Accepted Answer

A stable cash flow implies a steady and predictable revenue stream, which makes it easier for the company to make interest payments on its debt. On the other hand, a company with erratic cash flows may struggle to meet its debt obligations during periods of low cash flow, which increases the risk for lenders and may result in higher borrowing costs. Therefore, an MNC with stable cash flows can leverage more debt without significantly increasing its risk of default.

Question 15

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.

Accepted Answer

An MNC may deviate from its target capital structure in each country due to differences in market conditions, regulations, and risks. However, on a consolidated basis, the MNC can still achieve its overall target capital structure through adjustments in financing activities across countries.

Question 16

In general, an MNC's size, its access to international capital markets, and its international diversification increase the MNC's cost of capital.

Accepted Answer

An MNC's size, access to international capital markets, and international diversification can actually decrease its cost of capital due to increased bargaining power and lower risk through diversification.

Question 17

An MNC's cost of capital may differ from that of domestic firms because of the MNC's access to international capital markets, its exposure to exchange rate risk, and other characteristics.

Accepted Answer

Multinational corporations have access to international capital markets, which can have different interest rates and risk profiles compared to domestic markets. Additionally, MNCs may face exposure to exchange rate risk due to their operations in multiple countries. These factors can all affect the cost of capital for an MNC and may differ from that of domestic firms.

Question 18

When a host country announces a plan to block funds remitted to the subsidiary's parent, the subsidiary is likely to use a strategy of increasing local debt financing.

Accepted Answer

If the host country announces a plan to block funds remitted to the subsidiary's parent, the subsidiary may face a shortage of funds from the parent company. In such a situation, the subsidiary is likely to use a strategy of increasing local debt financing to fulfill its financial requirements. This is because local debt financing is a reliable source of funds that can be accessed easily and quickly without relying on the parent company.

Question 19

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.

Accepted Answer

The cost of capital for the MNC overall could change because the cost of debt and equity can vary significantly across different countries due to differences in tax rates, interest rates, and risk. Therefore, shifting debt between the subsidiary and the parent company could impact the overall cost of capital for the MNC.

Question 20

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

Accepted Answer

Capital asset pricing theory (CAPM) suggests that the cost of capital for an MNC is lower than that of a domestic firm because MNCs have a more diversified portfolio of assets and can spread their risks across different countries and markets. This lower cost of capital enables MNCs to pursue more investment opportunities and expand their operations globally.

Quiz 17: Multinational Capital Structure and Cost of Capital