Finance 3616

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MULTINATIONAL CAPITAL STRUCTURE and COST OF CAPITAL
➢ Capital structure – refers to the proportion of LT debt and equity and the particular forms of capital chosen to finance the assets of the firm ➢ Mgment must choose:
■ the proportions of D and E
■ the currency of denomination
■ fixed or floating rate interest payments
■ indenture provisions
■ conversion features
■ seniority
■ maturity

o Perfect mkt assumptions:
-frictionless mkts
-equal access to mkt prices
-rational investors
-equal access to costless information

MM’s irrelevance proposition
o With = access to perfect financial mkts, individuals can replicate any financial action that the firm can take o This leads to MM’s famous irrelevance proposition:
-if financial mkts are perfect, then corporate financial policy is irrelevant

The converse of MM’s irrelevance proposition
o If financial policy is to increase value, then it must either -increase the firm’s expected future cash flows or
-decrease the discount rate
in a way that cannot be replicated by individual investors.

Financial Mkt integration v Segmentation
o In integrated financial mkts, real after tax rates of return on equivalent asset are = o Factors contributing to segmentation include:
-prohibitive transactions costs
-different legal and political systems
-regulatory interference (eg barriers to financial flows)
-different taxes
-information barriers
-home asset bias (a tendency to buy financial assets in the domestic market) -differential investor expectations

Project valuation and the cost of capital
➢ Alternative approaches to project valuation
-WACC: weighted average cost of capital
-APV: adjusted present value
➢ Use of an asset specific discount rate that reflects the opportunity cost of capital -cash flows denominated in the domestic (foreign) currency should be discounted at a domestic (foreign) discount rate -nominal (real) CFs should be discounted at nominal (real) discount rate

o Adjusted present value (APV)
❖ The value of the unlevered or all-equity project + PV (financing side effects: ie value of tax shields from the use of debt net of costs of the expected financial distress) minius initial investment

Total v Systematic risks
❖ If operating risks are diversifiable, then they are not priced by Iors and should not be reflected n capital costs ❖ If operating risks are nondiversifiable, then they should be reflected in capital costs. -capital costs are increased if these risks are positively related to the mkt portfolio -capital costs are decreased if these risks are negatively related to the mkt portfolio

Sources of funds for multinational operations
❖ The financial pecking order:
-internally generated funds are the preferred source
-external sources of funds are accessed only after internal sources are exhausted • External debt is the preferred external funding source • New external equity is used only as a last resort

Sources of funds for multinational operations:
Internal sources External sources
MNC’s home countryCF from the parent and fromNew debt or equity Affiliates in the parent’s homecountryfinancing (perhaps issued or guaranteed by the parent corporation)

Foreign project’s host
CountryCF from existing operations in Local debt or equity
from institutions or
Operations in the host countrymkts in the host country

Internatinoal financing
SourcesCF redistributed from other foreignEurobonds,
AffiliatesEuroequity
Project finance

Leverage increases with
• The proportion of fixed to total assets
• Firm size

Leverage decreases with
• Mkt to book ratios (gwth opportunities)
• Profitability

CURRENCY FUTURES CONTRACTS...
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