Cost of Capital and Capital

Structure in a Global Context

Reported by: Arjoe S. de Guzman, MM, MBA
Mae Kathleen S. Aquino LPT,MBA
Topic

I. Determining the cost of capital for

multinational corporations
II. The impact of global capital structure
on financing decisions
III. Cross-border financing options and
international debt financing
What is Cost Capital?
• The cost of capital determines
the minimal return required to
support a capital budgeting
project, such as building a new
factory. It is an assessment of
whether a proposed choice can
be justified by its cost.
Weighted Average
Cost of Capital (WACC)
• A firm's cost of capital is
commonly estimated using the
weighted average cost of capital
formula, which takes into
account the cost of both debt
and equity capital.
 • The weighted average
cost of capital
represents the average
cost of the company's
capital, weighted
according to the type
of capital and its share
on the company
balance sheet. This is
determined by
multiplying the cost of
each type of capital by
How Do You the percentage of that
Calculate the type of capital on the
company's balance
Weighted Average sheet and adding the
Cost of Capital? products together.
 • Example:
• A small business loan of $300,000 which has a 6%
interest rate from the bank. Another one is a $100,000
loan from a businessman with an interest rate of 4%.
• The cost of debt is merely the interest
rate paid by the company on its debt. • Now, here is how the numbers, in this case, play out:
However, since interest expense is tax- • Total annual interest of both the debts
deductible, the debt is calculated on an • = [($300,000 x 6%) + (4% x $100,000)]
after-tax basis as follows: • = $18,000 + $4,000
• = $22,000
• Total Debt amount = $400,000
Cost of Debt= Interest Expenses/Total Debt x (1-T)
• So, Total Cost of Debt = $22,000 / $300,000
• = 5.5%
• Where:
Interest Expenses= Interest paid on the firm’s current

debt.
• The effective pre-tax interest rate the business pays
T= The company’s marginal tax rate to service all its debts is 5.5%.
The Cost of Equity

• The cost of equity is more • CAPM (Cost of Equity)= Rƒ + β (Rᵐ - Rƒ)

• Where:
complicated since the rate of
• Rƒ = risk-free rate of return
return demanded by equity
• Rᵐ = market rate of return
investors is not as clearly
defined as it is by lenders. The
• Beta is used in the CAPM formula to estimate risk,
cost of equity is approximated and the formula would require a public company's
by the own stock beta.
capital asset pricing model as
follows:
Why Is Cost of Capital
Important?

• Most businesses strive to grow and

expand. There may be many options:
expand a factory, buy out a rival, or
build a new, bigger factory. Before the
company decides on any of these
options, it determines the cost of
capital for each proposed project.
Multinational Cost
Capital

• An MNC’s capital represents its debt and

its equity, its cost of capital is based on
its cost of debt and its cost of equity. An
MNC’s cost of debt depends on the
interest rate that it pays when borrowing
funds. The interest rate that it pays is
equal to the risk-free rate at the time it
borrows funds along with a credit risk
premium that compensates creditors for
accepting credit risk when extending
credit to the MNC.
Estimating
an MNC’s
Cost of
Capital
Comparing Costs of Debt and
Equity

There is an advantage to
using debt rather than equity
as capital because the
interest payments on debt
are tax deductible. The
greater the use of debt,
however, the greater the
interest expense and the
higher the probability that
the firm will be unable to
meet its expenses.
Cost of Capital
for MNCs versus
Domestic Firms

•The cost of capital for MNCs may

differ from that for domestic firms
because of the following
characteristics that distinguish MNCs
from domestic firms. Size of Firm,
Access to International Capital
Markets, International Diversification,
Exposure to Exchange Rate Risk,
Exposure to Country Risk
Size of Firm

•An MNC that often borrows

substantial amounts may receive
preferential treatment from
creditors, thereby reducing its cost
of capital.
Access to
International
Market

•Multinational corporations are

normally able to obtain funds
through the international capital
markets.
International
Diversification

•If a firm’s cash inflows come from

sources all over the world, those
cash inflows may be more stable
because the firm’s total sales will
not be strongly influenced by a
single economy.
Exposure to
Exchange Rate
Risk

•An MNC’s cash flows could be

more volatile than those of a
domestic firm in the same industry
if it is highly exposed to exchange
rate risk. If foreign earnings are
remitted to the U.S. parent, they
will not be worth as much when
the U.S. dollar is strong against
major currencies.
Exposure to Country Risk

An MNC that establishes foreign

subsidiaries is subject to the
possibility that a host country
government may seize a
subsidiary’s assets.
II. The Impact
of Global
Capital
Structure on
Financing
Decision
• The global capital structure
impacts financing decisions in
various way. Capital structure
is the particular combination
of debt and equity used by a
company to finance its overall
operations and growth. The
global component complicates
these decisions due to
variances in financial markets,
legislation, and economic
situations between countries.
1. Access to
Finance Markets
• Diversification of Sources: The
topic of access to finance and
financial inclusion has been of
growing interest throughout the
world, particularly in emerging
and developing economies.
1. Access to
Finance Markets
• Market Conditions: Market
conditions refers to economic
and financial factors that affect
the construction industry.
2. Cost of
Capital
• Interest Rates: Interest rate risk
is the risk associated with
interest rate fluctuations in
assets. Interest rates and bond
prices are inversely related.
2. Cost of
Capital
• Currency Risk: Currency risk, or
exchange rate risk, refers to the
exposure faced by investors or
companies that operate across
different countries, in regard to
unpredictable gains or losses due to
changes in the value of one currency
in relation to another currency.
3. Regulatory and
Tax Considerations

• Regulating Variations: A special

or regulatory tax is imposed
primarily for the regulation of
useful or non-useful occupation
or enterprises and secondarily
only for the purpose of raising
public funds.
3. Regulatory and
Tax Considerations

• Tax Implications: Tax

implications refer to the financial
impact that a decision or action
can have on an organization's tax
liability.
• ” Taxation is no longer a measure merely to raise revenue to support the
existence of government. Taxes may be levied with a regulatory purpose to
provide means for the rehabilitation and stabilization of a threatened industry
which is affected with public interest as to be within the police power of the
State. The oil industry is greatly imbued with public interest as it vitally affects the
general welfare.”
• - Caltex V Commissioner 208 SCRA 705
4. Economic and
Political Risk
• Economic Risk: Economic risk is
the risk when we have major
change in the economic
structure, that will bring
changes in the expected return
of investment.
4. Economic and
Political Risk
• Political Risk : Political risk
comes from the changes in a
country's political structure or
its policies, such as tax laws,
tariffs, expropriation of assets,
or restriction in repatriation of
profits.
5. Strategic
Flexibility
• Mergers and acquisitions:
Mergers and acquisitions (M&A)
are the different ways companies
are combined. Entire companies or
their major business assets are
consolidated through financial
transactions between two or more
companies
5. Strategic
Flexibility
• Growth Opportunities: A
growth opportunity refers
to any situation or initiative that
allows a business to expand its
operations, increase revenue,
enhance its market presence or
improve profitability.
6. Financial
Reporting and
Transparency
• Complexity in Reporting: The
growing complexity of business
transactions, and greater
investor, regulatory and public
scrutiny have all added to the
demands on financial reporting.
6. Financial
Reporting and
Transparency
• Investor Perception: An investor
perception study might even
reach out to potential investors
and analysts who are involved
with peer companies but not
the issuer itself.
III. Cross-border financing
options and international debt
financing
What is • Cross-border financing refers to the
process of providing funding for
business activities that occur outside a
cross border country's borders. Companies that seek
cross-border financing want to compete
financing? globally and expand their business
beyond their current domestic borders.
What are • Debt Financing- Debt financing is the
act of raising capital by borrowing
the types of money from a lender or a bank, to be
repaid at a future date. In return for a
cross-border loan, creditors are then owed interest
on the money borrowed.
financing?
What are • Equity Financing- Equity financing is
the process of raising capital through
the types of the sale of shares. Both private and
public companies raise money for
cross-border short-term needs to pay bills or long-
term projects by selling ownership of
financing? their company in return for cash.
What are • Trade Financing- Trade finance
represents the financial instruments and
products that are used by companies to
the types of facilitate international trade and
commerce. Trade finance makes it possible
cross-border and easier for importers and exporters to
transact business through trade.
financing?
What are • Project Financing- Project financing
is a loan structure that relies primarily
the types of on the project's cash flow for
repayment, with the project's assets,
cross-border rights, and interests held as secondary
collateral.
financing?
 Advantage of
Cross-Border
Financing

Many companies opt for cross-border financing services when they have
global subsidiaries (e.g., a Canadian-based company with one or more
subsidiaries located in select countries in Europe and Asia). Opting in for
cross-border financing solutions can allow these corporations to maximize
their borrowing capacity and access the resources they need for sustained
global competition.
Cross-border factoring is a type of cross-border financing that provides
businesses with immediate cash flow that can be used to support growth
and operations. In this type of financing, businesses will sell their
receivables to another company.
 Disadvantage of
Cross-Border
Financing

In cross-border financing, currency risk and political risk are two potential
disadvantages. Currency risk refers to the possibility companies may lose money
due to changes in currency rates that occur from conducting international trade.
When structuring terms of a loan across nations and currencies, companies may
find it challenging to obtain a favorable exchange rate.
Political risk refers to the risk a company faces when doing business in a foreign
country that experiences political instability. Shifting political climates—
including elections, social unrest, or coups—could hinder a deal’s completion or
turn a profitable investment into an unprofitable one. For this reason, some
providers of cross-border financing may restrict doing business in certain regions
of the world.
 What Are the Risks in
Cross-Border Transactions?

• The risk of cross-border transactions is the risk that an entity

will not be able to receive payments from its customers due to
government measures that put restrictions on the convertibility
and transferability of foreign currencies. This risk arises from
problems within the foreign currency, such as political risk, as
opposed to risks associated with a specific customer.
Why Is Cross-Border
Trade Important?
• Cross-border trade is important because it allows individuals
and companies access to the best services and technologies.
This allows for efficiency and a reduction in costs, which
benefit the economy overall. Cross-border trade also increases
the market size in which individuals and companies can
conduct business, leading to higher revenues. The free flow of
data across borders lifts up everyone partaking in cross-border
trade.
Example of Cross-
Border Financing
• Computer World agrees to sell its $10 billion semiconductor unit to a
consortium led by Private Equity Partners LLC. The group of
investors include large American tech companies.
• The acquisition requires the U.S.-headquartered companies within the
consortium to obtain Japanese yen to complete the deal. Private
Equity Partners LLC also requires upwards of $2 billion from a few of
the companies to close the negotiation. The advantage to these
American companies participating in a cross-border deal is that it
helps ensure them continued access to Computer World's prized
semiconductor chips for their businesses.
END OF REPORT