Introduction to Global Business

Page 380

M u l t i n a t i o n al C a p i t al B u dge t i n g

357

14-4b The Cost of Capital: Domestic Versus Global The cost of capital is the required rate of return demanded by stock and bond investors. In the above NPV analyses, the cost of capital was the discount rate assumed to be 15 percent. The following well-known formula can be used to compute the weighted average cost of capital for a firm: K = (Equity/Total Market Value) R + (Debt/Total Market Value) (1 − Tax Rate) I where

Equity = market value of common and preferred stock outstanding Debt = market value of long-term debt outstanding R = cost of equity or required rate of return of equity holders I = before-tax cost of debt or interest rate Tax Rate = marginal tax rate of the firm Total Market Value = Equity + Debt.

The costs of equity R and the cost of debt I increase as the debt, or financial leverage, of the firm increases due to increased bankruptcy risk. Notice that higher taxes can reduce the cost of capital, or K, due to higher interest deductions on debt payments. If firms can reduce their cost of capital by lowering costs of equity and debt, changes in the combination of debt and equity they use (i.e., capital structure), or tax management, they can increase the value of NPVs on investment projects. In the above example, lowering the cost of capital below 15 percent would increase the NPV on the German computer chip subsidiary. The cost of debt is readily measured by calculating a weighted average of different interest rates paid by the firm on sources of long-term borrowings. MNCs are able to borrow beyond domestic borders in international capital markets and thereby minimize their cost of debt. International banks and bond markets increase access to loanable funds at competitive interest rates. The cost of equity is more difficult to estimate. The Capital Asset Pricing Model5 (CAPM) is a well-known approach to estimating the cost of domestic equity. The CAPM is written as follows: Rit = Rft + βi(Rmt − Rft), where Rit = the one-month return on stock i in month t Rmt = the one-month return on a domestic market index (e.g., the S&P 500 index of the 500 largest U.S. firms) Rft = the one-month riskless rate of return (e.g., the U.S. Treasury bill rate) βi = the domestic beta risk measure for the stock. As an example, given average Rmt = 10 percent, average Rft = 5 percent, and bi = 0.80, the cost of equity equals 9 percent computed as 5 + 0.80(10 − 5). The beta risk measure is less than one, which implies that the stock has lower risk than the market index. Firms with lower betas will have lower costs of equity than higher beta firms. One problem in estimating the cost of equity is whether the stock’s equity market is domestic or global. If investors in the domestic market set the price of the stock, a segmented market for the stock exists, and the CAPM is an appropriate way to measure the cost of equity. However, if international investors set the stock price, then an integrated market exists, such that the CAPM is inappropriate. Internationally integrated equity markets require the use of the International CAPM6 (ICAPM) to estimate the cost of equity. The ICAPM can be written as follows:

cost of capital

the required rate of return demanded by stock and bond investors and is used in net present value capital ­budgeting analyses as the ­discount rate

weighted average cost of capital the sum of the costs of equity and debt weighted by the amount of financing from these two capital sources

cost of debt

the weighted average of different interest rates paid on longterm borrowings

cost of equity

the required rate of return by stockholders in a firm and is estimated by means of the Capital Asset Pricing Model (CAPM)

beta risk

a measurement of the general market risk of a stock in the Capital Asset Pricing Model (CAPM)

international CAPM (ICAPM)

an asset pricing model that includes both domestic and global market factors to estimate the cost of equity or required rate of return on stocks

Copyright 2017 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.


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15-5b Evaluating Trends

2min
page 403

15-2d Differences Between U.S. GAAP and Selected Countries

13min
pages 397-401

15-5a Financial Ratios

2min
page 402

15-2a U.S. GAAP

2min
page 395

14-3d Government Financing

5min
pages 375-376

14-4b The Cost of Capital: Domestic Versus Global

6min
pages 380-381

14-2-1 Futures Contracts

6min
pages 365-366

13-5b The Role of Information Technologies

30min
pages 353-364

14-3c International Stock Markets

5min
pages 373-374

13-4c Relocation of Production Facilities

1min
page 351

13-4b Location of Production Facilities for Products

3min
page 350

13-4a Location of Production Facilities for Components and Raw Materials

3min
page 349

12-6d Transfer Pricing

31min
pages 330-342

13-3a Advantages of Making

2min
page 347

13-2c Outsourcing and Insourcing

8min
pages 344-346

12-6c Dumping

3min
page 329

13-3b Disadvantages of Making

3min
page 348

12-5b Physical Distribution

8min
pages 325-327

12-5a Channels of Distribution

2min
page 324

12-3c Where to Locate Research and Development Facilities

2min
page 320

11-4c Comparative Labor Relations

14min
pages 305-312

12-4b Sales Promotion

3min
page 322

12-3b Managing Existing Products

2min
page 319

11-2a Virtual Staffing

3min
page 297

12-4c Publicity

2min
page 323

11-1-3 Regulatory Issues Including Immigration and Border Security

5min
pages 294-295

11-1-4 Outsourcing and Offshoring

1min
page 296

10-4a Functional Structure

2min
page 271

11-1-2 Cultural Issues and Differences

5min
pages 292-293

10-4b Divisional Structure

6min
pages 272-274

10-4d Matrix Structure

25min
pages 277-290

11-1-1 Statistical Overview

2min
page 291

10-4c Hybrid Structure

3min
pages 275-276

10-3a Creating an Export Department

2min
page 269

9-5b Organizational Change

27min
pages 257-268

9-4-2 Interpersonal Controls

1min
page 252

9-4-3 Output Controls and Measurement

8min
pages 253-255

9-3a Impediments to Coordination

3min
page 249

9-1a Mission Statement

3min
page 243

9-4-1 Bureaucratic Controls

3min
page 251

9-3b Knowledge Management and Systems

3min
page 250

9-5a Types of Organizational Culture

2min
page 256

9-1b Shareholders Versus Stakeholders

6min
pages 244-246

8-3b Cost-Minimizing Strategies

3min
page 228

7-6b Computer Security of Accounting Information

17min
pages 209-217

8-1f Cross-Border Mergers and Acquisitions

2min
page 223

8-3a Revenue Maximizing Strategies

5min
pages 226-227

8-3c Risk Minimizing Strategies

3min
page 229

8-3d Dunning’s Eclectic Theory of Foreign Direct Investment

6min
pages 230-231

7-4a Enron

2min
page 199

7-6a Foreign Corrupt Practices Act

4min
pages 207-208

7-3a Rules, Policies, and Guidelines

2min
page 196

7-3b Ethics Codes at Selected Companies

5min
pages 197-198

7-2a Ethics and Economics

3min
page 193

6-5c Copyrights

18min
pages 185-192

6-4g Dispute Settlement Law

5min
pages 181-182

6-4d Tax Law

3min
page 179

6-4a Legal Systems

4min
pages 176-177

6-3c Corruption

3min
page 174

6-3a Econimic Risks

3min
page 171

6-3b Political Risks

4min
pages 172-173

6-2c Capitalism

3min
page 170

5-6d Communication

19min
pages 159-168

5-6c Advertising Campaigns

3min
page 158

5-6b Product Development and Management

2min
page 157

5-6a Management Styles

2min
page 156

5-5a Cultural Dimensions of Doing Business in Japan

2min
page 152

5-2a Language

2min
page 141

4-4b Interest Rate Parity

29min
pages 128-140

5-2b Religion

3min
page 142

5-3d Gannon’s Cultural Metaphors

2min
page 151

4-4a Purchasing Power Parity

5min
pages 126-127

4-3e Hard and Soft Currencies

3min
page 125

3-2b Major Classes and Characteristics of Regional Integration

18min
pages 88-95

2-4b Geopolitical Rationale

24min
pages 74-83

3-1b Pros and Cons of Regional Integration

4min
pages 85-86

3-2a Steps to Regional Integration

2min
page 87

4-1b The Financial Account

5min
pages 116-117

2-3b Nontariff Barriers

7min
pages 71-72

2-4a Socioeconomic Rationale

3min
page 73

2-3a Tariffs, Preferential Duties, and Most Favored Nation Status

3min
page 70

1-6a Job Losses and Income Stagnation

2min
page 46

2-2a Wealth Accumulation as a Basis for Trade Theory: Mercantilism

3min
page 63

1-6b Sustainable Development and Environmental Degradation

4min
pages 47-48

1-7a Globalization’s Winners and Losers

1min
page 49

2-2b Specialization as a Basis for Trade Theory: Absolute and Comparative Advantage

5min
pages 64-65

1-5d How Countries “Leapfrog” into the Internet and Cell Phone Era

3min
page 45

1-5c The Digital Divide Myth

1min
page 44

1-2b The World Bank

2min
page 35

1-2c The World Trade Organization

2min
page 36

1-4b Competitive Markets

3min
page 41

1-3b Transparency of Political Institutions

1min
page 38

1-1b Decoupling and the Move to a Multipolar World Economic Order

5min
pages 31-32

1-2a The International Monetary Fund

5min
pages 33-34

1-3a What Is Institutional Structure?

2min
page 37

1-3c Adaptive Institutions to Strengthen Public Participation

1min
page 39
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