International CapitalStructure and the Costof CapitalChapter Thirteen
ChapterObjectives:This chapter discusses the cost ofcapital for the multinational firm
❖Chapter Objectives: ❖This chapter discusses the cost of capital for the multinational firm
ChapterOutlineCost of CapitalCost of Capital in Segmented vs. IntegratedMarketsDoes the Cost of Capital Differ AmongCountries?*Cross-Border Listings of StocksCapital Asset Pricing Under Cross-ListingsThe Effect of Foreign EquityOwnershipRestrictionsThe Financial Structure of Subsidiaries
Chapter Outline ❖Cost of Capital ❖Cost of Capital in Segmented vs. Integrated Markets ❖Does the Cost of Capital Differ Among Countries? ❖Cross-Border Listings of Stocks ❖Capital Asset Pricing Under Cross-Listings ❖The Effect of Foreign Equity Ownership Restrictions ❖The Financial Structure of Subsidiaries
CostofCapital The cost of capital is the minimum rate ofreturn an investment project mustgenerate in order to pay its financingcosts.For a levered firm, the financing costs canbe represented by the weighted averagecost of capital:K= (1 - 2)K, + (1 - )i
Cost of Capital ❖The cost of capital is the minimum rate of return an investment project must generate in order to pay its financing costs. ❖For a levered firm, the financing costs can be represented by the weighted average cost of capital: K = (1 – )Kl + (1 – t)i
Weighted Average Cost ofCapitalK = (1 - 2)K, + 2(1 - t)iWhereK = weighted average cost of capitalK, = cost of equity capital for a levered firmi = pretax cost of debta = debt to total market value ratiot = marginal corporate income tax rate
Weighted Average Cost of Capital Where K = weighted average cost of capital Kl = cost of equity capital for a levered firm i = pretax cost of debt = debt to total market value ratio t = marginal corporate income tax rate K = (1 – )Kl + (1 – t)i
TheFirm'sInvestmentDecisionand the Cost of CapitalA firm that can reduce(%) d its cost of capital willincrease the profitablecapital expendituresocalthat the firm can takeon andincrease theglobalwealth of theshareholdersIRRInternationalizing thefirm's cost of capital isInvestmIglobalIyocalone such policy
The Firm’s Investment Decision and the Cost of Capital ❖A firm that can reduce its cost of capital will increase the profitable capital expenditures that the firm can take on and increase the wealth of the shareholders. ❖Internationalizing the firm’s cost of capital is one such policy. Investment ($) K global K local Ilocal Iglobal IRR
Cost ofCapitalinSegmentedvs. Integrated MarketsThe cost of equity capital (K.) of a firm is theexpected return on the firm's stock thatinvestors requireThis return is frequently estimated using theCapital Asset Pricing Model (CAPM):R,= R,+ β(RM- R)Cov(R,R)whereVar(RM
Cost of Capital in Segmented vs. Integrated Markets ❖The cost of equity capital (Ke ) of a firm is the expected return on the firm’s stock that investors require. ❖This return is frequently estimated using the Capital Asset Pricing Model (CAPM): where bi= Cov(Ri ,RM) Var(RM) Ri = Rf + bi (RM – Rf )
Cost ofCapitalinSegmentedvs. IntegratedMarketsIf capital markets are segmented, then investors canonly invest domestically. This means that the marketportfolio (M) in the CAPM formula would be thedomestic portfolio instead of the world portfolioR,= R,+ β,S(Ru.s. - R)versusR,= R,+ β (Rw- R)Clearly integration or segmentation of international financialmarkets has major implications for determining the cost of capital
Cost of Capital in Segmented vs. Integrated Markets If capital markets are segmented, then investors can only invest domestically. This means that the market portfolio (M) in the CAPM formula would be the domestic portfolio instead of the world portfolio. versus Clearly integration or segmentation of international financial markets has major implications for determining the cost of capital. Ri = Rf + bi (RU.S. – Rf ) U.S. Ri = Rf + bi (RW – Rf ) W
Does theCostofCapitalDiffer among Countries?There do appear to be differences in thecost of capital in different countries.When markets are imperfect, internationalfinancing can lower the firm's cost ofcapital.One way to achieve this is tointernationalize the firm's ownershipstructure
Does the Cost of Capital Differ among Countries? ❖There do appear to be differences in the cost of capital in different countries. ❖When markets are imperfect, international financing can lower the firm’s cost of capital. ❖One way to achieve this is to internationalize the firm’s ownership structure
RealAfter-TaxCostofFunds8U.S.642UK0-279777880 8182838485868788899092Source:RobertMcCauleyandStevenZimmer,"ExchangeRatesandInternational Differences inthein Y.Amihud and R.Levich, Exchange Rates and CorporatePerformance(Burr Ridge,Il: Irwin 1994
Real After-Tax Cost of Funds Source: Robert McCauley and Steven Zimmer, “Exchange Rates and International Differences in the Cost of Capital” in Y. Amihud and R. Levich, Exchange Rates and Corporate Performance (Burr Ridge, Ill; Irwin 1994). 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 8 6 4 2 0 -2 UK U.S