MGMT 415 Session 10 - Cost of Capital (1).pptx

MGMT 415 Session 10 - Cost of Capital (1).pptx - The cost...

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The cost of capital for foreign investments MGMT 415 International Financial Management Prof. Mara Faccio MGMT 41500 International Financial Management 1
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We will measure all (4) types of cost of capital in home currency (e.g., $) terms . We are assuming that we are U.S.-based investors. These rates are to be used to discount cash flows denominated in US$. “Equivalent” rates can be determined to discount cash flows denominated in foreign currencies. We will see examples of these foreign currency “equivalents” for the risk-free rate. 2
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I. The risk-free rate Source: Financial Times , , 3/11/2011 International Money Market Rates Are these rates risk- free ? 3
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I. The risk-free rate What is the expected rate of return from investing $1m in euros & $1m in yen? 1.73%*1/2+0.42%*1/2=1.08% 4
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I. The risk-free rate What does risk-free mean? The yield to maturity must be obtainable with certainty! No risk of default; No exchange rate risk; No interest rate risk (notice that interest rates vary by maturity – term structure of interest rates). (Most of) The rates in the previous table refer to loans/investments denominated in foreign currencies. For example, the 1.73% rate in the top/right corner, is the rate of return that we will earn if we invest Euros for one year... 5
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I. The risk-free rate: USES Direct use: It is the appropriate discount rate to use to discount the cash flows (interests and principal repayment) of a risk-free bond. Price of risk free bond = Present value of cash flows discounted at risk-free rate. Note: Remember to match currency & maturity. Input used to determine the cost of debt. Input used to determine the cost of equity (in CAPM). 6
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I. The risk-free rate Source: Financial Times , , 3/11/2011 7
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I. The risk-free rate … we could exchange today $1m for €722,543.4 (at the spot rate of $1.3840/€), and invest the euros at 1.73%; In one year we will have, with certainty , €735,043.4… which we can exchange for dollars at the spot rate that will exist at the time (e 1 ), for a total dollar value of e 1 *€735,043.4. This $-amount is uncertain …: Thus, from the perspective of a U.S.
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