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Chapter 17: Multinational Cost of Capital and Capital Structure
1. An argument for an MNC to have a debt-intensive capital structure is that:
a.
it can reduce the MNC’s exposure to exchange rate risk on earnings remitted by subsidiaries to the parent.
b.
it can reduce the chance of bankruptcy.
c.
it spreads the shareholder base.
d.
it forces subsidiaries to pay dividends to shareholders.
2. MNCs headquartered in Japan and Germany tend to use a higher degree of financial leverage than MNCs headquartered
in the United States.
a.
True
b.
False
3. According to the text, the cost of capital for an international project will:
a.
always be greater than the firm's cost of capital.
b.
always be less than the firm's cost of capital.
c.
always be the same as the firm's cost of capital.
d.
none of the above
4. Which of the following factors is generally not expected to have a favorable impact on an MNC’s cost of capital
according to the text?
a.
easy access to international capital markets
b.
high degree of international diversification
c.
high exposure to exchange rate fluctuations
d.
all of the above
5. The capital asset pricing theory is based on the premise that:
a.
only unsystematic variability in cash flows is relevant.
b.
only systematic variability in cash flows is relevant.
c.
both systematic and unsystematic variability in cash flows are relevant.
d.
neither systematic nor unsystematic variability in cash flows is relevant.
6. Which of the following is a corporate characteristic that may affect an MNC’s capital structure decision?
a.
the MNC’s cash flow stability
b.
its access to retained earnings
c.
its credit risk
d.
All of the above may affect an MNC’s capital structure decision.
7. An MNC’s "global" capital structure is:
a.
the MNC’s capital structure in the United States.
b.
the MNC’s capital structure relative to the structures of competitors across all countries.
c.
the MNC’s capital structure where it has its largest subsidiary.
d.
the combination of the capital structures of the parent and all of its subsidiaries.
8. An MNC's "global" target capital structure is:
a.
always debt intensive.
b.
always equity intensive.
c.
sometimes different from the MNC's "local" capital structure (at a subsidiary).
d.
none of the above
9. One argument for why subsidiaries should be wholly owned by the MNC parent is that parent ownership avoids a
potential conflict of interest between the:
a.
parent’s managers and board of directors.
b.
parent and managers at the subsidiary who are minority shareholders.
c.
parent and existing creditors.
d.
subsidiary’s managers and creditors.
10. One argument for why subsidiaries should be allowed to issue their own stock is that:
a.
it prevents a potential conflict of interests between the MNC's managers and shareholders.
b.
it prevents a potential conflict of interests between the MNC's majority shareholders and minority
shareholders.
c.
it prevents a potential conflict of interests between the MNC's existing creditors.
d.
having local investors as minority shareholders may offer some protection against adverse actions by the local
government.
11. The cost of capital incurred by U.S.-based MNCs is primarily driven by global stock market volatility.
Chapter 17: Multinational Cost of Capital and Capital Structure
a.
True
b.
False
12. Other things being equal, countries with relatively ____ populations and ____ inflation are more likely to have a low
cost of capital.
a.
young; high
b.
old; high
c.
old; low
d.
young; low
13. Other things being equal, the financial leverage of MNCs will be higher if the governments of their home countries are
____ likely to rescue them (in the event of failure), and if their home countries are ____ likely to experience a recession.
a.
more; more
b.
less; more
c.
less; less
d.
more; less
14. Based on the factors that influence a country's cost of capital, the cost of capital in less developed countries is likely to
be ____ than in the United States and ____ than in Japan.
a.
higher; higher
b.
higher; lower
c.
lower; lower
d.
lower; higher
15. According to the text, the cost of debt in each country:
a.
is somewhat stable over time.
b.
changes over time, and these changes are negatively correlated among countries.
c.
changes over time, and these changes are positively correlated among countries.
d.
changes over time, and these changes are not correlated among countries.
16. The term "local capital structure" is used in the text to represent the:
a.
average capital structure of local firms where the MNC's subsidiary is based.
b.
average capital structure of local firms where the MNC's parent is based.
c.
capital structure of a subsidiary of a particular MNC.
d.
capital structure of a particular MNC overall (including all subsidiaries).
17. Which of the following is not an external source of debt for an MNC?
a.
a private placement of bonds
b.
borrowing from a financial institution
c.
a domestic bond offering
d.
borrowing in the federal funds market
18. An MNC may deviate from its target capital structure in each country where financing is obtained, yet still achieve its
target capital structure on a consolidated basis.
a.
True
b.
False
19. Assume that the risk-free interest rate in the United States is the same as that in Country M. Assume that the
government of Country M is more likely to rescue local firms that experience financial problems. Other things being
equal, Country M's firms are likely to use a ____ degree of financial leverage than U.S. firms. If a firm based in Country
M has the same degree of financial leverage and the same operating characteristics as a U.S. firm, its cost of capital will
likely be ____ than that of the U.S. firm.
a.
higher; higher
b.
higher; lower
c.
lower; lower
d.
lower; higher
20. When a country's risk-free rate rises, the cost of equity to an MNC in that country _____, and the cost of debt to an
MNC in that country ____, other things held constant.
a.
increases; increases
b.
increases; is not affected
c.
is not affected; increases
d.
is not affected; is not affected
21. Which of the following is not a characteristic that favorably affects an MNC's cost of capital, compared to the cost of
Chapter 17: Multinational Cost of Capital and Capital Structure
capital for a domestic firm?
a.
the MNC’s exposure to exchange rate risk
b.
the MNC’s size
c.
the MNC’s access to international capital markets
d.
the MNC’s international diversification
22. According to your text, which of the following is not a factor that increases an MNC's cost of capital?
a.
higher exposure to exchange rate risk
b.
higher exposure to country risk
c.
an increase in the risk-free interest rate
d.
an increase in the size of the MNC
23. The ____ an MNC, the ____ its cost of capital is likely to be.
a.
larger; higher
b.
larger; lower
c.
smaller; lower
d.
A and C
24. Zoro Corp. has a beta of 2.0. The risk-free rate of interest is 5 percent, and the return on the stock market overall is
expected to be 13 percent. What is the required rate of return on Zoro stock?
a.
21 percent
b.
41 percent
c.
16 percent
Chapter 17: Multinational Cost of Capital and Capital Structure
d.
13 percent
e.
none of the above
25. Which of the following is not a reason provided in the text for why the cost of debt can vary across countries?
a.
differences in the risk-free rate
b.
a high price-earnings multiple
c.
differences in the credit risk premium
d.
differences in demographics
26. In general, MNCs probably prefer to use ____ foreign debt when their foreign subsidiaries are subject to ____ local
interest rates.
a.
more; low
b.
more; high
c.
less; low
d.
B and C
e.
none of the above
27. In general, MNCs probably prefer to use ____ foreign debt when their foreign subsidiaries are subject to potentially
____ local currencies.
a.
more; strong
b.
more; weak
c.
less; strong
Chapter 17: Multinational Cost of Capital and Capital Structure
d.
less; weak
e.
B and C
28. A firm's cost of ____ reflects an opportunity cost: what the existing shareholders could have earned if they had
received the earnings as dividends and invested the funds themselves.
a.
debt
b.
retained earnings
c.
short-term loans
d.
none of the above
29. The ____ an MNC's cost of capital, the ____ will be the net present value for a proposed project with a given set of
expected cash flows.
a.
lower; higher
b.
higher; higher
c.
lower; lower
d.
none of the above
30. To the extent that individual economies are ____ each other, net cash flows from a portfolio of subsidiaries should
exhibit ____ variability, which may reduce the probability of bankruptcy.
a.
dependent on; less
b.
dependent on; more
c.
independent of; less
d.
independent of; more
31. In general, an MNC that is ____ exposed to exchange rate fluctuations will usually have a ____ distribution of
possible cash flows in future periods.
a.
more; narrower
b.
less; wider
c.
more; wider
d.
none of the above
32. According to the CAPM, the required rate of return on a stock is a positive function of all of the following, except:
a.
the risk-free rate of interest.
b.
the market rate of return.
c.
the stock's beta.
d.
the company's earnings.
33. The lower a project's beta, the ____ is the project's ____ risk.
a.
lower; systematic
b.
lower; unsystematic
c.
higher; systematic
d.
higher; unsystematic
34. Capital asset pricing theory suggests that ____ risk of projects can be ignored and that ____ risk is relevant.
a.
unsystematic; unsystematic
b.
unsystematic; systematic
c.
systematic; unsystematic
d.
systematic; systematic
35. Capital asset pricing theory would most likely suggest that the cost of capital is generally ____ for ____.
a.
higher; MNCs
b.
lower; domestic firms
c.
lower; MNCs
d.
none of the above
36. When assuming that investors in the United States are most concerned with their exposure to the U.S. stock market, it
is acceptable to use the U.S. market when measuring a U.S.-based MNC's project's beta.
a.
True
b.
False
37. Assume that an MNC has very stable cash flows and uses very little debt. Its cost of debt should be:
a.
lower than its cost of equity.
b.
higher than its cost of equity.
c.
lower than the country's risk-free rate.
Chapter 17: Multinational Cost of Capital and Capital Structure
d.
lower than its credit risk premium.
38. Normally, each subsidiary of an MNC will issue its own stock where it does business.
a.
True
b.
False
39. In general, an MNC's size, its access to international capital markets, and its international diversification increase the
MNC's cost of capital.
a.
True
b.
False
40. Country differences, such as differences in the risk-free interest rate and differences in risk premiums across countries,
can cause the cost of capital to vary across countries.
a.
True
b.
False
41. Because their economies have lower growth, the cost of debt in industrialized countries is much higher than the cost of
Chapter 17: Multinational Cost of Capital and Capital Structure
debt in many less developed countries.
a.
True
b.
False
42. In the United States, government rescues of failing firms are not as common as they are in some other countries.
Assuming that this is expected to continue in the future, the risk premium on a given level of debt would be higher for
U.S. firms than for firms in countries where government rescues are more common, everything else being equal.
a.
True
b.
False
43. An MNC's cost of equity is unrelated to the local risk-free rate.
a.
True
b.
False
44. Assume a subsidiary is forced to borrow in excess of the MNC's optimal capital structure. Also assume that the parent
company reduces its debt financing by an offsetting amount. Under this scenario, the cost of capital for the MNC overall
could not have changed.
a.
True
b.
False
45. Because increased external financing by a foreign subsidiary reduces the external financing needed by the parent, such
an action will not affect the MNC's overall cost of capital.
a.
True
b.
False
46. Since the cost of funds can vary among markets, an MNC's access to the international capital markets may allow it to
attract funds at a lower cost than that paid by domestic firms.
a.
True
b.
False
47. Capital asset pricing theory would most likely suggest that the MNC's cost of capital is lower than that of domestic
firms.
a.
True
b.
False
48. An MNC with stable cash flows can probably handle more debt than an MNC with erratic cash flows.
a.
True
b.
False
49. When MNCs pursue international projects that have a high potential for return, but also increase their risk, this
increases the return to the bondholders that provided credit to the MNCs.
a.
True
b.
False
50. There is an advantage to using equity rather than debt financing because dividend payments are tax deductible.
a.
True
b.
False
51. An MNC's cost of capital may differ from that of domestic firms because of the MNC’s access to international capital
markets, its exposure to exchange rate risk, and other characteristics.
a.
True
b.
False
52. When a host country announces a plan to block funds remitted to the subsidiary’s parent, the subsidiary is likely to use
a strategy of increasing local debt financing.
a.
True
b.
False
53. The capital asset pricing model (CAPM) suggests that the required return on a firm's stock is a positive function of the
risk-free rate of interest and the market rate of return and a negative function of the stock's beta.
a.
True
b.
False
54. The cost of an MNC’s capital can be measured as the cost of its debt plus the cost of its equity, with appropriate
weights applied to reflect the percentages of debt and equity.
a.
True
b.
False
55. It is always advantageous to use foreign debt to finance a foreign project, particularly in developing countries.
a.
True
b.
False
56. It is probably easier to estimate the cost of equity than it is to estimate the cost of debt.
a.
True
b.
False
Chapter 17: Multinational Cost of Capital and Capital Structure
57. When a firm issues stock in a country with weak laws on corporate disclosure and little legal protection for
shareholders, the stock will generally be sold at a relatively ______ price, so the firm incurs a _____ cost of equity.
a.
low; low
b.
low; high
c.
high; high
d.
high; low
58. If a parent MNC backs the debt of a foreign subsidiary, the borrowing capacity of the parent might be reduced because
creditors may not be willing to provide as many funds to the parent if those funds may possibly be needed to rescue the
subsidiary.
a.
True
b.
False
59. Based on the CAPM, the ____ the beta of a project, the ____ the required rate of return on that project.
a.
higher; higher
b.
lower; higher
c.
higher; lower
d.
B and C
e.
none of the above
60. The capital asset pricing model suggests that the required return on a firm's stock is a positive function of:
a.
the risk-free rate of interest.
b.
the market rate of return.
c.
the stock's beta.
d.
all of the above
61. Which of the following is not a source of equity for an MNC?
a.
retained earnings
b.
a global equity offering
c.
a domestic equity offering
d.
All of the above are sources of equity for an MNC.
62. Werner Corporation has a target capital structure that consists of 40 percent debt and 60 percent equity. Werner can
borrow at an interest rate of 10 percent. Also, Werner has determined its cost of equity to be 14 percent. Werner's tax rate
is 40 percent. What is Werner's weighted average cost of capital?
a.
10.8 percent
b.
12.4 percent
c.
9.2 percent
d.
none of the above
63. The U.S. risk-free rate is currently 3 percent. The expected U.S. market return is 10 percent. Solso, Inc. is considering
a project that has a beta of 1.2. What is the cost of dollar-denominated equity?
a.
8.4 percent
b.
11.4 percent
c.
10.0 percent
d.
None of the above
64. Which of the following is least likely to influence an MNC's capital structure?
a.
stability of the MNC's cash flows
b.
the MNC's credit risk
c.
the MNC's access to earnings
d.
the MNC's decision to invest excess cash in a Treasury bill rather than in a bank
65. Which of the following is not a host country characteristic than can affect an MNC's capital structure decision?
a.
the strength of the host country currency
b.
the country risk in the host country
c.
political decisions to increase penalties for criminals in the host country
d.
tax laws in the host country
66. If the parent ____ the debt of the subsidiary, the subsidiary's borrowing capacity might be ____.
a.
does not back; increased
b.
backs; reduced
c.
does not back; reduced
Chapter 17: Multinational Cost of Capital and Capital Structure
d.
backs; increased
e.
C and D
67. ____ are beneficial because they may reduce transaction costs. However, MNCs may not be able to obtain all the
funds that they need.
a.
Private placements
b.
Domestic equity offerings
c.
Global equity offerings
d.
Global debt offerings
68. Most MNCs obtain equity funding:
a.
in foreign countries.
b.
in their home country.
c.
through global offerings.
d.
through private placements.
