Exam 17: International Capital Structure and the Cost of Capital

ABC Inc.,located in Halifax,produces towels and is considering the establishment of a foreign operation in Indonesia ABC wants to know its weighted average cost of capital and the cost of capital of an equivalent all-equity financed firm.The interest rate on Indonesian government securities is 18% and on Canadian government securities it is 5%.The Indonesian income tax rate is 40% and the Canadian income rate is 35%.ABC Inc.debt-to-equity ratio is 1: 3 and its cost of equity financing is 12%.

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Question 1

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Weighted Average cost of capital:
Kwacc = 0.25*(1 .35)*(0.05)+ 0.75*.12 = 0.098 or 9.8%.
Cost of an all-equity financed firm:
.098 = Ku(1 .35*.25)
Ku = .098/.9125 = .1074 or 10.74%

The adjusted present value (APV)model that is suitable for an MNC is the basic net present value (NPV)model expanded to:

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Question 2

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Which cash flows are relevant for the international capital budgeting analysis?

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Question 3

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The only relevant cash flows in capital budgeting are the incremental cash flows,those that are attributable to the capital expenditure.This implies that sunk costs must be ignored.In the international context it is especially important to consider additional sales by the parent or other subsidiaries that may be generated due to the new facility.However,the new facility may also result in lower sales of other subsidiaries or the parent if a market is no longer served with exports.These lost sales or this cannibalization must also be considered in the capital budget.

Is it possible that a project has a positive APV from the subsidiary's perspective and a negative APV from the parent's perspective?

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Question 4

Company Y,a Canadian manufacturer of boats,is currently exporting $100,000 worth of boats to the United States.The firm is considering opening a production facility in the United States because without a presence in the United States,the entire US market would be lost to a competitor.The new facility would produce boats for about $800,000 and the firm anticipates total sales in the United States to be $900,000.When analyzing this project,Company X should:

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Question 5

The discount rates to use for the APV calculations are:

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Question 6

Company X,a Canadian manufacturer of chairs,is currently exporting $100,000 worth of chairs to the United States.The firm is considering opening a production facility in the United States that would produce enough chairs for the entire US market and is predicting total sales in the United States to be $500,000.When analyzing this project,Company X should:

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Question 7

Capital budgeting analysis is very important,because it:

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Question 8

Given the following information for a levered and unlevered firm,calculate the difference in the cash flow available to investors. Assume the corporate tax rate is 40%. (Hint: Calculate the tax savings arising form the tax deductibility of interest payments).

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Question 9

The current spot rate between the Canadian dollar and the Euro is C$1.6000/euro.The Canadian and European inflation rates are expected to be 2% and 4% per year for the next 10 years respectively.Using purchasing power parity to predict the exchange rate in 10 years,the predicted exchange rate is:

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Question 10

Sensitivity analysis in the calculation of the adjusted present value (APV)allows the financial manager to:

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Question 11

Which of the following statements is false about "borrowing capacity"?

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Question 12

The "net present value" of a capital project is calculated by using:

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Question 13

The financial manager's responsibilities involve:

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Question 14

The option to quit a foreign project early is called:

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Question 15

In the context of the capital budgeting analysis of an MNC that has strong foreign competitors,"lost sales" refers to:

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Question 16

The APV is calculated using the following formula:

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Question 17

Which of the following is not an example of a real option?

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Question 18

The "incremental" cash flows of a capital project are calculated by using:

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Question 19

When using the adjusted present value (APV)to evaluate a capital budgeting problem,the appropriate discount rate for foreign loans is

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Question 20

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The adjusted present value (APV)model that is suitable for an MNC is the basic net present value (NPV)model expanded to:

Which cash flows are relevant for the international capital budgeting analysis?

Is it possible that a project has a positive APV from the subsidiary's perspective and a negative APV from the parent's perspective?

The discount rates to use for the APV calculations are:

Capital budgeting analysis is very important,because it:

Given the following information for a levered and unlevered firm,calculate the difference in the cash flow available to investors. Assume the corporate tax rate is 40%. (Hint: Calculate the tax savings arising form the tax deductibility of interest payments).

The current spot rate between the Canadian dollar and the Euro is C$1.6000/euro.The Canadian and European inflation rates are expected to be 2% and 4% per year for the next 10 years respectively.Using purchasing power parity to predict the exchange rate in 10 years,the predicted exchange rate is:

Sensitivity analysis in the calculation of the adjusted present value (APV)allows the financial manager to:

Which of the following statements is false about "borrowing capacity"?

The "net present value" of a capital project is calculated by using:

The financial manager's responsibilities involve:

The option to quit a foreign project early is called:

In the context of the capital budgeting analysis of an MNC that has strong foreign competitors,"lost sales" refers to:

The APV is calculated using the following formula:

Which of the following is not an example of a real option?

The "incremental" cash flows of a capital project are calculated by using:

When using the adjusted present value (APV)to evaluate a capital budgeting problem,the appropriate discount rate for foreign loans is

Globalization and the Multinational Firm

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The Market for Foreign Exchange

International Parity Relationships and Forecasting Foreign Exchange Rates

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