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Borrow Local Funds –if the subsidiary borrows funds locally, local banks will be concerned about its future performance. If for any reason a government takeover would reduce the probability that the banks would receive their loan repayments promptly, they might attempt to prevent a takeover by the host government. Purchase Insurance –insurance can be purchased to cover the risk of expropriation. Many home countries of MNCs have investment guarantee programs that insure to some extent the risks of expropriation, wars, or currency blockage. Use Project Finance –many of the world’s largest infrastructure projects are structured as “project finance” deals, which limit the exposure of the MNCs. First, project finance deals are heavily financed with credit. Thus, the MNC’s exposure is limited because it invests only a limited amount of equity in the project. Second, a bank may guarantee the payments to the MNC. Third, project finance deals are unique in that they are secured by the project’s future revenues from production. Thus, the cash flows of the project are relevant, and not the credit risk of the borrower. Chapter Seventeen: Multinational Capital Structure and Cost of Capital MNCs rely on capital to finance their expansion of existing subsidiaries, the creation of new subsidiaries, and other projects. Since the MNC’s decisions regarding its capital structure determine its cost of capital and the cost of capital affects the profitability on its projects, its capital structure decisions affect its value.
Components of Capital An MNC needs capital to expand its operations. If an MNC’s parent decides to establish a foreign subsidiary, it may invest its own cash into the subsidiary. The cash infusion in the subsidiary represents an equity investment by the parent, so that the parent is the sole owner of the subsidiary. The subsidiary uses the cash infusion to develop its business operations in the host country, and it can remit earnings to the parent over time as a means of providing return on the parent’s equity investment.An alternative method by which the subsidiary can build more equity is to offer its own stock to the public, assuming that it receives approval from the MNC’s parent. If shares of the subsidiary stock are sold to investors in the host country, the subsidiary would no longer be wholly owned by the parent. If an MNC allows a subsidiary to issue its own stock, it may also offer the managers of the subsidiary shares of this stock as partial compensation in order to encourage then to make decisions that maximize the value of the stock. The subsidiary is more likely to increase its equity over time by retaining earnings than by issuing its own stock. When an MNC has foreign subsidiaries, its overall capital structure is the combination of the capital structures of the parent and all subsidiaries. In general, an MNC can increase its capital internally by retaining earnings or externally by issuing debt or equity.