TUTORIAL EXERCISE WEEK 24
INTERNATIONAL COST OF CAPITAL AND CAPITAL STRUCTURE
By investing in the form of debt rather than equity, companies may be able to reduce their taxes (because principal repayments are treated as a return of capital and are not taxed) and to avoid currency controls (because governments are more reluctant to block loan repayments, than dividend payments).
Use the interest rate parity:
One year forward rate: £1*1.13 = $2*1.10
⇨ £1 = $1.9469, which is 2.65% down from exchange rate today. ⇨ Breakeven, with company indifferent between borrowing in UK at 13% or in US at 10%, if £ depreciate by 2.65% per annum.
Exchange rate in 5 years:
£1* (1.13)5 = $2*(1.10)5 = £1.8424 = $3.2210
£1 = $1.7482
$1 = £0.5720
3. This is a discussion question, with no clear solution. Factors which may contribute to national variations in capital structure include but are by no means restricted to: • differences in accounting practices (which may exaggerate perceived differences in capital structure); • differences in tax legislation (which may affect the attractiveness of debt, e.g., through the impact of tax-deductible interest payments); • differences in bankruptcy laws (affect the cost of financial distress associated with excess gearing); • development of capital markets (is equity finance readily available - e.g., liquid stock market?); • levels of profitability (pecking-order - companies prefer to finance investments with retained earnings. Highly profitable firm may rely on retained earnings rather than debt (or new equity) finance).
Whether national differnces in financing patterns affect cost of capital is a controversial issue. Rajan and Zingales argue that “It is doubtless more important for a company to worry about making the right investment that about exactly how to finance it.”
INTERNATIONAL CAPITAL BUDGETING
The key aspect is the risk of the project. Does it fit with what the company is doing...
Please join StudyMode to read the full document