Cost of Capital. An MNC has total assets of $100 million and debt of $20 million. The firm’s before-tax cost of debt is 12%, and its cost of financing with equity is 15%. The MNC has a corporate tax rate of 40%. What is this firm’s cost of capital?
Optimal Financing. Wizard, Inc., has a subsidiary in a country where the government allows only a small amount of earnings to be remitted to the United States each year. Should Wizard finance the subsidiary with debt financing by the parent, equity financing by the parent, or financing by local banks in the foreign country?
|Wizard should use financing by local banks in the foreign country.|
|Wizard should use debt financing by local banks in the foreign country.|
|Wizard should use equity financing by local banks in the foreign country.|
Change in Cost of Capital. Assume that Naperville Co. will use equity to finance a project in Switzerland, while Lombard Co. will rely on a dollar-denominated loan to finance a project in Switzerland, and Addison Co. will rely on a Swiss franc-denominated loan to finance a project in Switzerland. The firms will arrange their financing in one month. This week, the U.S. risk-free long-term interest rate declined, but interest rates in Switzerland did not change. Do you think the estimated cost of capital for the projects by each of these three U.S. firms increased, decreased, or remained unchanged?
|Naperville decreased, Lombard Co. decreased, and Addison Co. remains unchanged.|
|Naperville increased, Lombard Co. increased, and Addison Co. remains unchanged.|
|Naperville remains unchanged, Lombard Co. remains unchanged, and Addison Co. decreased.|
|Naperville decreased, Lombard Co. increased, and Addison Co. remains unchanged.|
Financing Decision. Drexel Co. is a United States–based company that is establishing a project in a politically unstable country. It is considering two possible sources of financing. Either the parent could provide most of the financing, or the subsidiary could be supported by local loans from banks in that country. Which financing alternative is more appropriate to protect the subsidiary?
|The parent could provide most of the financing.|
|The subsidiary could be supported by local loans from banks in that country.|
Financing With Foreign Equity. Orlando Co. has its U.S. business funded in dollars with a capital structure of 60% debt and 40% equity. It has its Thailand business funded in Thai baht with a capital structure of 50% debt and 50% equity. The corporate tax rate on U.S. earnings and on Thailand earnings is 30%. The annualized 10-year risk-free interest rate is 6% in the United States and 21% in Thailand. The annual real rate of interest is about 2% in the United States and in Thailand. Interest rate parity exists. Orlando pays 3 percentage points above the risk-free rates when it borrows, so its before-tax cost of debt is 9% in the United States and 24% in Thailand. Orlando expects that the U.S. annual stock market return will be 10% per year, and the Thailand annual stock market return will be 28% per year. Its business in the United States has a beta of .8 relative to the U.S. market, while its business in Thailand has a beta of 1.1 relative to the Thai market. The equity used to support Orlando’s Thai business was created from retained earnings by the Thailand subsidiary in previous years. However, Orlando Co. is considering a stock offering in Thailand that is denominated in Thai baht and targeted at Thai investors. Estimate Orlando’s cost of equity in Thailand that would result from issuing stock in Thailand.
Cost of Equity. Wiley, Inc., an MNC, has a beta of 1.3. The U.S. stock market is expected to generate an annual return of 11%. Currently, Treasury bills yield 2%. Based on this information, what is Wiley’s estimated cost of equity?
Cost of Capital and Risk of Foreign Financing. Nevada Co. is a U.S. firm that conducts major importing and exporting business in Japan, and all transactions are invoiced in dollars. It obtained debt in the United States at an interest rate of 10% per year. The long-term risk-free rate in the United States is 8%. The stock market return in the United States is expected to be 14% annually. Nevada’s beta is 1.2. Its target capital structure is 30% debt and 70% equity. Nevada Co. is subject to a 25% corporate tax rate. Estimate the cost of capital to Nevada Co.
Debt Financing Decision. Marks Co. (a U.S. firm) considers a project in which it will establish a subsidiary in Zinland, and it expects that the subsidiary will generate large earnings in zin (the currency). However, it is the Zinland government’s policy to block all funds so that earnings cannot be remitted to the U.S. parent for at least 10 years; furthermore, the blocked funds cannot earn interest. The zin is expected to weaken by 20% per year against the dollar over time. Marks Co. will borrow some funds to finance the subsidiary. Should the company (a) obtain a dollar-denominated loan and convert the loan into zin, (b) obtain a zin-denominated loan, or (c) obtain half of the funds needed from each possible source? (Assume that the interest rate from borrowing zin is the same as the interest rate from borrowing dollars).
|Obtain a dollar-denominated loan and convert the loan into zin|
|Obtain a zin-denominated loan|
|Obtain half of the funds needed from each possible source|
Cost of Capital. Blues, Inc., is an MNC located in the United States. Blues would like to estimate its weighted average cost of capital. On average, bonds issued by Blues yield 9%. Currently, Treasury security rates are 3%. Furthermore, Blues’ stock has a beta of 1.5, and the return on the Wilshire 5000 stock index is expected to be 10%. Blues’ target capital structure is 30% debt and 70% equity. If Blues is in the 35% tax bracket, what is its weighted average cost of capital?
Cost of Equity. Illinois Co. is a U.S. firm that plans to expand its business overseas. It plans to use all equity to be obtained in the United States to finance a new project. The project’s cash flows are not affected by U.S. interest rates. Just before Illinois Co. obtains new equity, the risk-free interest rate in the United States rises. Will the change in interest rates increase, decrease, or have no effect on the required rate of return on the project?
|Have no effect|