Cost of Capital and Capital Structure

1
Chapter 17

• Cost of Capital and Capital Structure

2
Cost of Capital

• What is the cost of capital?
• What are the firms primary sources of funds?

3
Cost of Capital

• The firms WACC is given as
• Wd(kd)(1-T) Weke
• where

4
Cost of Capital

• What is the advantage of debt financing?
• Does this mean the firms should use 100 debt
  financing?

Cost of Capital
Debt ratio
5
Cost of Capital

• MNCs cost of capital may differ from that of
  domestic firms because of
• Size of the firm
• Access to international capital markets
• International diversification
• Exchange rate risk
• Country risk

6
Cost of Capital

• The cost of capital varies across countries.
  This implies that
• MNCs based in some countries have an inherent
  competitive advantage (more positive NPV
  projects)
• MNCs can adjust their operations and sources of
  funding to capitalize on differences across
  countries

7
Cost of Capital

• Why does the cost of capital vary across
  countries?
• Differences in the risk free rate
• Differences in the risk premium
• Note cost of debt is generally lower in Japan,
  highest in UK (Exhibit 17.3)

8
Capital Structure

• Factors influencing capital structure
• Stability of MNCs cashflows
• MNCs credit risk
• Access to retained earnings
• Parent guarantees on debt
• Restrictions on issuing stock

9
Capital Structure

• Interest rates in host countries
• Strength of host country currency
• Threat of blocked funds
• Tax laws in host countries

10
Capital Structure

• Global capital structure
• Local capital structure
• Should the MNC maintain its target capital
  structure on a local or global basis?

11
Capital Structure

• Advantages of maintaining capital structure on a
  local basis
• Disadvantages of mainitaing capital structure on
  a local basis

12
Capital Structure

• Advantages of maintaining capital structure on a
  global basis
• Disadvantages of maintaining capital structure on
  a global basis

13
Capital Structure

• Observations on capital structure in different
  countries
• Japanese and German firms tend to use more debt.
  Why?

14
Summary

• MNCs may have lower cost of capital than purely
  domestic firms
• Cost of capital varies across countries
• Capital structure tends to vary across countries
• MNC must decide whether to maintain its cost of
  capital on a local or global basis