CH19 - CHAPTER 19 THE COST OF CAPITAL FOR FOREIGN PROJECTS...

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CHAPTER 19 THE COST OF CAPITAL FOR FOREIGN PROJECTS CHAPTER OUTLINE I. The Weighted Average Cost of Capital a) Cost of equity b) Cost of debt c) The appropriate cost of capital II. Optimum Capital Structure a) Book-value versus market-value weights (1) Book-value weights (2) Market-value weights b) Implications III. The Marginal Cost of Capital and Investment Decisions (1) Optimum capital budget IV. Cultural Values and Capital Structure V. Summary 162
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CHAPTER OBJECTIVE Multinational companies should know the disparity in the cost of capital across countries because this disparity can affect their decisions on where to establish subsidiaries and where to obtain funds. Thus, this chapter explains why the cost of capital for multinational companies differ from those of domestic firms. It also explains why the cost of capital varies across countries. KEY TERMS AND CONCEPTS Weighted average cost of capital (WACC) is a weighted average of the component costs: the cost of debt, the cost of preferred stock, and the cost of equity. Cost of equity for a firm is the minimum rate of return necessary to attract investors to buy or hold a firm's common stock. Security market line consists of the riskless rate of interest and a risk premium. Market risk premium is the rate of return on a market portfolio minus riskless rate of interest. Price-earnings ratio is the price per share divided by the earnings per share. Explicit cost of debt may be defined as the discount rate that equates the net proceeds of the debt issue with the present value of interest and principal payments. Optimum capital structure is defined as the combination of debt and equity that yields the lowest cost of capital. Book value weights are derived from the stated values of individuals components of the capital structure of the firm's current balance sheet. Market value weights are based on the current market prices of bonds and stocks. Marginal cost of capital (MCC) is the cost of an additional dollar of new funds. Optimum capital budget is defined as the amount of investment that maximizes the value of the company. ANSWERS TO END-OF-CHAPTER QUESTIONS 1. Explain both systematic risk and unsystematic risk within the international context. Within the international context, systematic risk relates to such global events as worldwide recessions, world wars, and changes in the world energy supply. 163
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Unsystematic risk relates to such national events as expropriation, currency controls, inflation, and exchange rate changes. 2. What are the complicated factors in measuring the cost of debt for multinational companies? Multinational companies must account for a number of complicated factors to measure the cost of debt. First, multinational companies can borrow in Eurocurrency markets, international bond markets, or national capital markets. Hence, they must--in order to measure the before-tax cost of debt--estimate
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CH19 - CHAPTER 19 THE COST OF CAPITAL FOR FOREIGN PROJECTS...

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