tb16.docx
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Chapter16MultinationalCapitalStructureandtheCostofCapital
True/False
1.Afirm’scostofcapitalisindependentofitsfinancialstructure.
ANS:
False.Giventhefirm’sinvestments,financialstructuredeterminesthefirm’scostofcapital.
2.Capitalstructurereferstotherelativeproportionofmonetaryandrealassetsinthefirm.
ANS:
False.Capitalstructurereferstotheproportionsandformsoflong-termdebtandequitycapitalusedtofinancetheassetsofthefirm.
3.Thegoaloffinancialpolicyistominimizethefirm’soverallcostofcapital,giventhefirm’sassets.
ANS:
True.
4.Iffinancialmarketsareperfectandtherearenotaxes,thencorporatefinancialpolicyisvitallyimportanttothefirm’sstakeholders.
ANS:
False.Iffinancialmarketsareperfect,thencorporatefinancialpolicyisirrelevant.
5.Iffinancialmarketsareperfect,thenthevalueofanassetisdeterminedbythevalueofexpectedfutureinvestmentcashflowsandnotbythewaythatitisfinanced.
ANS:
True.
6.Inintegratedfinancialmarkets,nominalratesofreturnonequivalentassetsareequal.
ANS:
False.Inintegratedmarkets,realafter-taxrequiredreturnsonequivalentassetsareequal.
7.Iffinancialmarketsareintegratedandsystematicriskistobemeasuredagainstamarketportfolio,thentheappropriatechoiceofamarketportfolioisthedomesticmarketindex.
ANS:
False.Theworldmarketindexistheappropriatemarketportfolio.
8.Ifgoodsandfinancialmarketsaresegmentedacrossnationalbordersbutareotherwiseefficient,thenmultinationalcorporationscanreducetheircostofcapitalthroughforeigndirectinvestmentorthroughfinancingfromforeignsourcesorboth.
ANS:
True.
9.Onbalance,marketsegmentationhurtsthemultinationalcorporationmorethanthedomesticcorporation.
ANS:
False.Themultinationalcorporationmaybeabletogainaccesstonewinvestmentsorfinancingatmorefavorableratesthanareavailabledomestically.
10.Ifinvestorsarerestrictedfromsomemarketsbycapitalflowbarriers,thenthemultinationalcorporationwithaccesstothesemarketscanprovideindirectdiversificationbenefitstoinvestors.
ANS:
True.
11.Ahighercostofcapitalonforeigninvestmentcouldariseifaforeigngovernmentrequiresthatatleastapartoftheforeigninvestmentbefinancedlocally.
ANS:
True.
12.Foreignpoliticalrisksincreasethevariabilityofoutcomesonforeigninvestmentprojects.
ANS:
True.
13.Thetotalriskofaforeigninvestmentislikelytobegreaterthansimilardomesticinvestments.
ANS:
True.
14.Thetotaloperatingriskofaforeigninvestmentcouldbegreaterthantheriskofasimilardomesticinvestment,andyettheinvestmentcouldhavealowerrequiredreturnthanasimilardomesticinvestment.
ANS:
True.
15.Inperfectandintegratedfinancialmarkets,multinationalcorporationsareabletoachievediversificationbenefitsthatcannotbereplicatedbyindividualinvestorsorportfoliomanagers.
ANS:
False.Investorscanalreadydiversifyforthemselvesinperfect,integratedfinancialmarkets.
16.Inaperfectandintegratedfinancialmarket,investorscanreduceoreveneliminatethecurrencyriskexposuresoftheirportfoliosthroughtheirownportfoliohedginganddiversificationstrategies.
ANS:
True.
17.Intherealworld,hedgingcanincreasethefirm’sexpectedcashflowsbyreducingexpectedtaxes,bankruptcycosts,andagencycosts.
ANS:
True.
18.Whenevaluatingnewinvestmentalternatives,themultinationalcorporationshoulduseadiscountratethatreflectsthesystematicriskofotherassetsinthatcountry.
ANS:
False.Useanasset-specificdiscountratethatreflectstheriskoftheproposedinvestment.
19.Accordingtotheweightedaveragecostofcapitalapproachtoprojectvaluation,operatingcashflowsarediscountedattherequiredreturnofleveredequitycapital.
ANS:
False.After-taxoperatingcashflowstodebtandequityarediscountedataweightedaverageofafter-taxrequiredreturnsondebtandequitycapital.
20.Discountratesonnewinvestmentsshouldreflectthediscountratesonthefirm’sexistingassetsandthefirm’sexistingdebt-equitymix.
ANS:
False.Thediscountrateshouldreflectthesystematicoperatingriskanddebtcapacityoftheproposedinvestment.
21.Discountingafter-taxcashflowstodebtandequityattheweightedaveragecostofcapitalisthemostcommonlyusedmethodforprojectvaluationinmarketeconomies.
ANS:
True.
22.Thetargetdebtcapacityofaforeignprojectistheamountofdebtthatthefirmwouldchoosetoborrowiftheprojectwerefinancedasa“stand-alone”entity.
ANS:
True.
23.Thediscountrateinprojectvaluationshouldreflectthemixofdebtandequitythatisactuallyraisedtofinanceaparticularproject.
ANS:
False.Thediscountrateshouldreflectthetargetoroptimalmixofdebtandequity.
24.Thetargetdebtcapacityofaforeignprojectshouldreflectthefirm’sexistingassetsanddebt-equitymix.
ANS:
False.Debtcapacityisasset-specific.
25.Themarketportfolioinanintegratedfinancialmarketisthedomesticmarketindex.
ANS:
False.Themarketportfolioinanintegratedfinancialmarketisgloballydiversified.
26.Forinvestmentsindevelopedeconomies,thesecuritymarketlineisstillthemostpopularmethodforidentifyingequityrequiredreturns.
ANS:
True.
27.Thevalueofaforeigninvestmentdependsonthewayitisfinanced.
ANS:
True.
28.Adjustedpresentvalueisfoundbydiscountingcashflowstoleveredequityatadiscountratethatreflectsthesystematicriskofleveredequity.
ANS:
False.APVaddsthevalueoffinancingsideeffectstothevalueofunleveredequity.
29.Thesystematicbusinessriskofaprojectcanbeproxiedbythebetaofasimilarassetthatisfinancedwithonehundredpercentequity.
ANS:
True.
30.First-timeissuersofAmericandepositoryreceiptstendtoseeagaininshareprice.
ANS:
True.
31.Agencycostsarisefromconflictsofinterestbetweenthevariousinstitutionalownersofthefirm’sequity.
ANS:
False.Agencycostsarisefromconflictsbetweenmanagersandotherstakeholders.
32.Studiesfindthatinternationalequityissuesdonotsufferthesamedegreeofpost-issuanceunderperformanceasdomesticissuesdo.
ANS:
True.
33.Inthecapitalassetpricingmodel,diversifiablerisksdonotaffectthecostofcapital.
ANS:
True.
34.Whetherhighertotaloperatingrisksonforeigninvestmenttranslateintohighersystematicrisksdependsonlyontheseverityofpoliticalrisksinthehostcountry.
ANS:
False.Whetherhighertotaloperatingrisksonforeigninvestmenttranslateintohighersystematicriskdependsonthetotalriskofforeigninvestmentandonthecorrelationofforeigninvestmentreturnswithinvestors’relevantmarketportfolio.
35.Mostempiricalstudiesthatstudythecostofcapitalofmultinationalcorporationsrelativetosimilardomesticcorporationsfindthattherisksofcross-borderoperationsresultinahighercostofcapitalforthemultinationalcorporation.
ANS:
False.Itdependsonthenatureoftherisks,especiallyonwhethertheyarediversifiable.Indeed,moststudiesfindlowercapitalcostsformultinationalcorporations.
36.Erb,Harvey,andViskanta[“PoliticalRisk,FinancialRiskandEconomicRisk,”FinancialAnalystsJournal,1996]foundthehighervolatilitiesofcompaniesinemergingmarketsresultedinhigherbetasthanoncomparableassetsindevelopedmarkets.
ANS:
False.Emergingmarkets’lowercorrelationswithothermarketstendtoovercometheirhighervolatilities,resultinginlowerbetasthanonsimilarassetsindevelopedmarkets.
MultipleChoice
1.Intheirfamousarticlesonthecostofcapital,corporationfinanceandthetheoryofinvestment,ModiglianiandMillermadeeachofthefollowingassumptionsexcept____.
a.equalaccesstobidandaskprices
b.homogeneousinvestorexpectations
c.homogeneousbusinessriskclasses
d.perpetualcashflows
e.rationalinvestors
ANS:
A
2.Factorscontributingtofinancialmarketsegmentationincludeeachofthefollowingexcept____.
a.differentinvestorexpectations
b.differentlegal,political,ortaxsystems
c.informationalbarriers
d.rationalinvestors
e.transactionscosts
ANS:
D
3.Foreignpoliticalriskincludeseachofthefollowingexcept____.
a.unexpectedchangesinexpropriationrisk
b.unexpectedchangesinforeignexchangerates
c.unexpectedchangesinlocalownershiplimitations
d.unexpectedchangesinrepatriationrestrictions
e.unexpectedchangesintaxes
ANS:
B
4.Whichofa)throughd)istrue?
a.Aparticularpoliticalriskismorelikelytobediversifiablebylocalinvestorsthanbyinternationalinvestors.
b.ApoliticalrisksuchasanelectionimposeshighercostsofcapitalonMNCsheldbygloballydiversifiedinvestors.
c.Fromtheperspectiveofmanagersinthemultinationalcorporation,politicalriskisnotdiversifiable.
d.Globalinvestorsareexposedtoamultinationalcorporation’stotalrisk,measuredbystandarddeviationofreturnintheinvestors’functionalcurrencies.
e.Noneoftheabove
ANS:
C
5.Afirm’sdebtsellsfor£10millionandequityfor£30million.Thefirm’sbefore-taxcostofdebtis9%.Itscostofequityis18%.Thecorporatetaxrateis33%.Thefirm’sweightedaveragecostofcapitalisclosesttowhichofthefollowing?
a.6%
b.9%
c.12%
d.15%
e.18%
ANS:
D
6.ThecostofcapitalforaprojectinSpainshould____.
a.beafunctionoftheriskinessoftheproject
b.equaltheminimumrateofreturnnecessarytoinduceinvestorstobuyorholdthefirm’sstock
c.equalthenomi
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