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Unit-3 Session 9

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35 views9 pages

Unit-3 Session 9

Uploaded by

sameer raza
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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COST OF CAPITAL FOR MNCS

vsDOMESTIC FIRMS
 Concept of cost of capital and methodology applied to compute it are invariably
the same both in case of domestic firms and MNCs, yet they differ in practice
because of several peculiar features of an MNC
Access to International Capital Markets:

 In view of easier access to international capital markets, MNCs are in a position to


obtain funds at lower cost than that paid by the domestic firms. Further,
international availability permits MNCs to maintain the desired ratio, even if
substantially large funds are required. This is not true in the case of domestic
firms.
Scale of Operations:

 International Financing Decisions MNCs generally being larger in size as


compared to the domestic firms may be in a privileged position to garner funds
both through stocks and bonds at lower cost because they are accorded
preferential treatment due to their size.
International Diversification:

 MNCs, by virtue of their diversified operations, are in a better position to reduce


their cost of capital in comparison to domestic firms for at least two reasons:
 A firm with cash inflows pouring in from different sources across the world
enjoys relatively greater stability, for the fact that total sales will not be greatly
influenced by a single economy. Less cash flow volatility causes the firm to
support a higher debt ratio leading to lower cost of capital;
 International diversification (by country and by product) should lower the
systematic risk of the firms, thus lowering its beta coefficient and consequently
the cost of equity.
Exposure to Exchange Rate Risk

 Operations of MNCs and their cash flows are exposed to higher exchange rate
fluctuations than domestic firms leading to greater possibility of bankruptcy. As a
result, creditors and stockholders demand a higher return, which enhances the
MNC's cost of capital.
Exposure to Country Risk:

 The total country risk of foreign investment, as noted earlier, is greater in the case
of foreign investment than in similar domestic investment because of the
additional cultural, political and financial risks of foreign investments. Thus, risks
increase the volatility of returns on foreign investment, often to the detriment of
the MNC.
DETERMINING CUT OFF RATE FOR
FOREIGN PROJECT APPRAISAL
 Adjusting for the Exchange Risk: The cost of capital of a foreign project may be
adjusted by the average rate of appreciation (depreciation) of the host country's
currency during the life of the project. In case of appreciation of home country
currency against the host country currency, cost of capital will be adjusted
downward.
Adjusting for Segmentation of Capital
Markets:
 Segmentation of capital markets, caused by government control on the flow of
capital across boundaries and the existence of varying degrees of depth and
development of capital markets in different countries and dearth of accurate
information on investment and lending opportunities in different markets,
influences the cost of capital of an MNC upward or downward.
Adjusting For the International
Diversification Effect:
 The beneficial impact of international diversification is reflected in reduced
exchange rate and country risks. As such risk premium for a project in case of an
MNC having portfolio of subsidiaries across different countries tends to be
relatively lower

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