Lecture 10:

The Global Cost of Capital

&
International debt and equity
financing
Lecturer: Dao Mai Huong
 Overview

Effect of market liquidity and

segmentation on cost of capital

WACC revised:

• Cost of equity

Outlines • Cost of debt

International CAPM

International equity financing

International debt financing

Overview: Global Cost and
Availability of Capital
 In emerging countries:
 The capital market remains undeveloped  highly illiquid and
segmented
 Firms too small to gain access to their own national securities markets.
 relatively high cost of capital and limited availability of capital, hence,
lower its competitiveness
 In industrialized countries with small capital markets:
 Firms source their long-term debt and equity at home in these partially
liquid domestic securities markets at lower costs
 These firms can tap the highly liquid global markets to strengthen their
competitive advantage.
The Effect of Market Liquidity and
segmentation on cost of capital

 Market liquidity: observed by noting the degree to which a firm

can issue a new security without depressing the existing market
price.
 Capital market segmentation is a financial market
imperfection caused mainly by government constraints,
institutional practices, and investor perceptions.
 Asymmetric information between domestic and foreign-based investors
 Lack of transparency
 High securities transaction costs
 Foreign exchange risks
 Political risks
 Corporate governance differences
 Regulatory barriers
The Effect of Market Liquidity and
segmentation on cost of capital
 A national securities market can be efficient in a
domestic context and yet segmented in an international
context
 If that market is segmented, foreign investors would not
participate
 Securities would be priced based on domestic rather than
international standards
Dimensions of the Cost and Availability of
Capital Strategy
The Effect of Market Liquidity and
segmentation on cost of capital

 The degree to which capital markets are illiquid or segmented has an

important influence on a firm’s marginal cost of capital (and thus on its
weighted average cost of capital).
 In the following exhibit:
 Return on capital at different budget levels is denoted as MRR.
 If the firm is limited to raising funds in its domestic market, the line
MCCD shows the marginal domestic cost of capital.
 If the firm has additional sources of capital outside the domestic (illiquid)
capital market, the marginal cost of capital shifts right to MCCF.
 If the MNE is located in a capital market that is both illiquid and
segmented, the line MCCU represents the decreased marginal cost of
capital if it gains access to other equity markets.
Market Liquidity, Segmentation, and the
Marginal Cost of Capital
The Effect of Market Liquidity and
segmentation on cost of capital
 Global integration of capital markets
 Many firms can access to new and cheaper sources of funds beyond those
available in their home markets.
 Firms being able to:
 Accept more long-term projects.
 Invest more in capital improvement &
expansion.
 If a firm is located in a country with illiquid, small,
and/or segmented capital markets, it can achieve this
lower global cost and greater availability of capital by
a properly designed and implemented strategy.
Weighted Average Cost of Capital


Weighted Average Cost of Capital

 WACC is used as risk-adjusted discount rate

whenever a firm’s new projects are in the same general
risk class as its existing projects.

 A project-specific required rate of return (other than

WACC) should be used as the discount rate if a new
project differs from existing projects in business or
financial risk
WACC: Cost of Debt

 Debts consist of different components: loans, bonds,

notes,…
 The normal procedure for measuring the cost of debt
requires:
1. Forecast: interest rates for the next few years, the
proportions of various classes of debt the firm expects to
use, and the corporate income tax rate.
2. The interest costs of different debt components are then
averaged (according to their proportion).
 Get the before-tax average cost of debt: kd

 After-tax cost of debt:kd(1-t)

WACC: Cost of Debt
WACC: Cost of Debt

EXAMPLE: If a U.S. based firm borrows CHF

1.5 million for 1 year at 5% interest, and
during the year the Swiss franc appreciates
from an initial rate of CHF 1.5/$ to CHF
1.44/$, what is the dollar cost of this debt ?
Tax rate = 34%
WACC: Cost of Equity
 The capital asset pricing model (CAPM) approach is to define
the cost of equity for a firm by the following formula:

ke = krf + βj(km – krf)

where
ke = expected (required) rate of return on equity
krf = rate of interest on risk-free bonds
βj = coefficient of systematic risk for the firm
km = expected (required) rate of return on the market
portfolio of stocks
Decision: Invest if equity’s return > required return
WACC: Cost of Equity

International CAPM (ICAPM)

ICAPM (modified CAPM) assumes the financial

markets are global, not just domestic.
keglobal = krfg + βjg(kmg – krfg)

 Risk-free rate, krfg, unlikely to change

 Market return, kmg, will change to reflect average expected
global market returns for the coming periods.
 The firm’s beta, βjg will change to reflect the expected
variations against a greater global portfolio
The Cost of Equity for Nestlé of
Switzerland
Equity Risk Premiums
 The corporation must annually determine which potential
investments it will accept and reject due to its limited capital
resources.
 If the company is not accurately estimating its cost of equity—
and therefore its general cost of capital—it will not be
accurately estimating the net present value of potential
investments
Equity Risk Premiums
Trident’s case
 Maria Gonzalez, Trident’s CFO, wants to calculate the
company’s WACC in both forms, the traditional CAPM and then
ICAPM.
 Maria assumes the risk-free rate of interest (krf) as 4%, using
the U.S. government 10-year Treasury bond rate. The
expected rate of return of the market portfolio (km) is assumed
to be 9%, held by a well-diversified domestic investor. Trident’s
estimate of its own systematic risk, its beta, against the
domestic portfolio is 1.2. Trident’s before tax cost of debt (kd)
estimated by observing the current yield on Trident’s
outstanding bonds combined with bank debt, is 8%. Corporate
income tax is 35%. Trident’s long-term capital structure is 60%
equity (E/V) and 40% debt (D/V).
Trident’s case

 A second calculation of Trident’s cost of equity using the ICAPM. As

Trident has globalized its own business activities, the investor base
that owns Trident’s shares has also globally diversified
 Trident’s beta, when calculated against a larger global equity
market index which includes these foreign markets and their
investors, is lower, 0.90. The expected market return for a larger
globally integrated equity market is a lower value as well, 8.00%.

 Ke (ICAPM) =
 WACC =
Cost of capital: MNEs vs domestic
counterparts
Chapter 14

International
Debt and Equity
Financing
Strategy to source capital globally

 Management agreement upon a long-run financial

objectives: established its financial strategy and
considered its desired and target capital structure,
The need for accessing global capital market
 Choosing among the various alternative paths and
designing a strategy that will ultimately attract
international investors.
 May require some restructuring of the firm, improving the
quality and level of its disclosure, and making its
accounting and reporting standards more transparent to
potential foreign investors.
Strategy to source capital globally

Role of investment banker: an official advisor to the firm.

 Help firm to determine the choice of paths and implementation
 In touch with the potential foreign investors and their current
requirements, help navigate the numerous institutional requirements and
regulatory barriers.
 Advising if, when, and where a cross-listing should be initiated.
 Prepare the required prospectus if an equity or debt issue is desired
 Help to price the issue and maintain an aftermarket to prevent the share
price from falling below its initial price.
Alternative Paths to Globalize the Cost and
Availability of Capital
Raising equity globally

 Three key critical elements when seeking to

raise equity capital.
 Equity issuance: sales of shares to the public
(IPO, SPO)
 Equity listing: Shares of a publicly traded firm
are listed for purchase or sale on an exchange
 Private placement: The sale of a security (equity
or debt) to a private investors (typically
institutions)
Equity Alternatives in the Global
Market to equity issuance
Equity Pathways

1. Initial Public Offering (IPO) –A private firm

initiates public ownership of the company through an IPO
 Begin with the organization of underwriters to assist the
company in preparation of the regulatory filings and
disclosures required.
 Before the IPO date, a prospectus is published.
 The IPO typically represents 15% to 25% of ownership.
 Later issues by the firm are considered “seasoned
offerings” (SPO)
 With public issuance of shares comes greater public
disclosure.
Equity Pathways

2. Euroequity Issue - is an initial public offering

on multiple exchanges in multiple countries at the
same time.
 Almost all Euroequity issues are underwritten
by an international syndicate
 The largest and most spectacular issues have been made
in conjunction with a wave of
privatizations of state-owned enterprises (SOEs)
Equity Pathways

3. Directed Public Share Issue – targeted at investors

in a single country
 underwritten in whole or in part by investment institutions from that
country
 might or might not be denominated in the currency of the target
market.
 typically combined with a cross-listing on a stock exchange in the target
market.
 might be motivated by a need to fund acquisitions or major capital
investments in a target foreign market
Equity Pathways

4. Private Placement – the sale of a security to

a small set of qualified institutional buyers.
 Since the securities are not registered for sale to the public,
investors have typically followed a “buy & hold” strategy.
 May refer to either equity or debt.
 Can take a variety of different forms & the intent of
investors may be passive (e.g., Rule 144A investors) or
active (private equity, where the investors intends to
control and change the firm).
Equity Pathways: Private placement

4. Private placement (Cont.)

 Rule 144A Private Placement Sale – sales of securities to
qualified institutional buyers (QIBs) in the United States without
SEC registration.
 SEC Rule 144A placements are proving attractive to foreign issuers of both equity
and debt securities.

 Private Equity – usually limited partnerships of institutional and

wealthy investors, that raise capital in the most liquid capital
markets.
 Buying control of publicly owned firms, taking the subject firms private, revitalizing
their businesses and then selling them publicly or private in 1 to 5 years.
Foreign Equity Listing and Issuance
objectives
 Cross-listing attempts to accomplish one or more of many
objectives:
 Improve the liquidity of its existing shares and support a liquid
secondary market for new equity issues in foreign markets
 Increase its share price by overcoming miss-pricing in a
segmented and illiquid home capital market
 Increase the firm’s visibility
 Establish a secondary market for shares used to acquire other
firms
 Create a secondary market for shares that can be used to
compensate local management and employees in foreign
subsidiaries
Barriers to Cross-Listing
and Selling Equity Abroad
Barriers to cross-listing and/or selling equity
abroad:
 Future commitment to providing full and transparent
disclosure of operating results and balance sheets
as well as a continuous program of investor
relations.
 Disclosure Is a Double-Edged Sword:
 Greater disclosure  lower cost of equity capital
 However, it narrows the choice of securities available to investors.
Raising Debt Globally

 The international debt market offers the borrower a

wide variety of different maturities, repayment
structures, and currencies of denomination.
 The markets and their many different instruments
vary by:
 source of funding,
 pricing structure,
 maturity, and
 subordination or linkage to other debt and equity instruments.
International Debt Markets and
Instruments
International Debt Markets
1. Bank loans and syndications:
 International bank loans: been sourced in the Eurocurrency
markets; attractive with a narrow interest rate spread (less
than 1%).
 Eurocredits are bank loans to MNEs, sovereign governments,
international institutions, and banks denominated in
Eurocurrencies and loan’s denominated currency is not the
lending bank's national currency.
 E.g. Eurodollar credit is a USD-denominated loan made by a bank outside
U.S.
 The syndication of loans has enabled banks to spread the
risk of very large loans among a number of banks. (Many large
MNEs need credit in excess of a single bank’s loan limit)
International Bond Markets

2. The Euronote market:

 Euronote Facilities: short-term, negotiable, promissory notes
underwritten by international investment and commercial banks
with substantially cheaper source of short-term funds than were
syndicated loan
 Euro-commercial paper (ECP): a short-term debt obligation of a
corporation or bank, normally
sold at a discount (usually denominated in US dollars)
 Euro medium-term notes (EMTN): basic characteristics are
similar to bond, typical maturities range from 9 months to 10
years, allowing continuous issuance over a period of time.
International Bond Markets

3. The International Bond Market: two generic

classifications
 A Eurobond is underwritten by an international syndicate
of banks and other securities firms and is sold exclusively in
countries other than the country whose currency the issue
is denominated
 A foreign bond is underwritten by a syndicate composed
of members from a single country, sold principally within
that country, and denominated in the currency of that
country. The issuer, however, is from another country.
International Bond Markets

 Unique Characteristics of Eurobond Markets:

 Absence of regulatory interference
• National governments often impose tight controls on foreign issuers of
securities denominated in local currencies. However, governments in
general have less stringent limitations for securities denominated in foreign
currencies and sold within their markets

 Less stringent disclosure

• Disclosure requirements less stringent than those of the SEC

 Favorable tax status

• Eurobonds offer tax anonymity and flexibility. Eurobonds are usually issued
in bearer form which is tied to tax avoidance

 Ratings: Purchasers of Eurobonds do not rely only on bond-

rating services or on detailed analyses of financial statements.
The case of Vietnam

 Hoang Anh Gia Lai issued a $90 million five-year bond with a
9.875% coupon in May 2011. Credit Suisse arranged the deal.
 VietinBank successfully issued its $250 million worth of
international bonds which is listed on Singapore Stock
Exchange.
 In 2018, Novaland listed its US$160 million offering of
convertible bonds on the Singapore Exchange, along with
$150 million equity placement.
 Vingroup issued 5-year debt notes for 325M USD as of June 6,
2018. Tradable on Singapore Stock Exchange as of July 16,
2018.
The case of Vietnam

 VietinBank’s 5 year international bond

- Type of bonds: Ordinary bonds, non-convertible, unsecured.
- Currency of issue: U.S. Dollar (USD)
- Volume of listed bonds: $250 million.
- Time limit listed: 05 years from the date of issue
- Date of issue: 05/17/2012
- Maturity date: 05/17/2017
- Interest stubs: Fixed rate 8%/year.
- Term of interest: 6 months / time
- Interest payment date: 05/17 and 11/17, annual
- Listed: Singapore Stock Exchange (SGX)
- Regulation: New York Law.
The case of Vietnam

 TH Group is planning to list its share on Singapore stock

exchange in 2020
 VNG Corporation is also conducting the IPO process and
expects to list its shares on Nasdaq
 Vietnamese firms are facing difficulties in listing
overseas due to the strict listing criteria set by
foreign stock exchanges and differences in
accounting standards. (Vietnam investment
review,2018)
Summary