Ch017.docx
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Ch017.docx
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Ch017
Eun&Resnick4e
CHAPTER17InternationalCapitalStructureandtheCostofCapital
CostofCapital
CostofCapitalinSegmentedversusIntegratedMarkets
DoestheCostofCapitalDifferamongCountries?
InternationalFinanceinPractice:
TheU.S.WelcomestheAlienInvasion
CASEAPPLICATION:
NovoIndustri
Cross-BorderListingsofStocks
CapitalAssetPricingunderCross-Listings
TheEffectofForeignEquityOwnershipRestrictions
Pricing-to-MarketPhenomenon
CASEAPPLICATION:
Nestlé
AssetPricingunderForeignOwnershipRestrictions
TheFinancialStructureofSubsidiaries
Summary
Appendix17A:
PricingofNontradableAssets:
NumericalSimulations
CostofCapital
1Thecostofcapitalis:
a)theminimumrateofreturnaninvestmentprojectmustgenerateinordertopayitsfinancingcosts
b)theminimumrateofreturnaninvestmentprojectmustgenerateinordertopayitsfinancingcostsplusareasonableprofit
c)themaximumrateofreturnaninvestmentprojectmustgenerateinordertopayitsfinancingcosts
d)themaximumrateofreturnaninvestmentprojectmustgenerateinordertopayitsfinancingcostsplusareasonableprofit
Answer:
a)
2Forafirmthathasbothdebtandequityinitscapitalstructure,itsfinancingcostcanberepresentedbytheweightedaveragecostofcapitalthatiscomputedby:
a)weighingthepre-taxborrowingcostofthefirmandthecostofequitycapital,usingthedebtastheweight
b)weighingtheafter-taxborrowingcostofthefirmandthecostofequitycapital,usingthedebtastheweight
c)K=(1–λ)Kl+λ(1-τ)i
where:
K=weightedaveragecostofcapital
Kl=costofequitycapitalforaleveragedfirm
i=before-taxborrowingcost
τ=marginalcorporateincometaxrate
λ=debt-to-total-market-valueratio
d)b)andc)
Answer:
d)
3Inthenotationofthebook,K=(1–λ)Kl+λ(1-τ)i
Whichofthefollowingarecorrect?
a)Thedebt-equityratioisλ
b)Thetaxrateisτ
c)Theafter-taxcostofdebtcapitalisi
d)Alloftheabove
Answer:
b)
4Attheoptimalcapitalstructure,
a)K=(1–λ)Kl+λ(1-τ)iwillbeminimized
b)Thedebt-equityratiowillbeequaltothedebt-to-valueratio.
c)K=(1–λ)Kl+λ(1-τ)iwillbemaximized
d)Noneoftheabove
Answer:
a)
5Findtheweightedaveragecostofcapitalforafirmthathasadebt-to-equityratioof1½,ataxrateof34%,aleveredcostofequityof12%andanafter-taxcostofdebtof8%
a)9.6%
b)7.968%
c)14%
d)noneoftheabove
Answer:
a)
Rationale:
Adebt-to-equityratioof1½ofcourseimpliesadebt-to-valueratioof60%
K=(1–λ)Kl+λ(1-τ)i=0.40×12%+0.60×8%(thedebtcostisgivenafter-tax).
K=9.6%
6Thecostofequitycapitalis:
a)theexpectedreturnonthefirm’sstockthatinvestorsrequire
b)frequentlyestimatedbyusingtheCapitalAssetPricingModel(CAPM)
c)generallyconsideredtobealinearfunctionofthesystematicriskinherentinthesecurity
d)alloftheabove
Answer:
d)
7Areducedcostofequitycapitalincreasesthefirm’svalue:
a)Throughrevaluationofthefirm’sexistingcashflowsfromexistingprojects.
b)ThroughincreasedinvestmentasmoreprojectsbecomepositiveNPVs
c)Botha)andb)
d)Noneoftheabove
Answer:
c)
8Findtheweightedaveragecostofcapitalforafirmthathasadebt-to-equityratioof1½,ataxrateof34%,aleveredcostofequityof12%andapre-taxcostofdebtof10%
a)9.6%
b)7.968%
c)8.76%
d)noneoftheabove
Answer:
c)
Rationale:
Adebt-to-equityratioof1½ofcourseimpliesadebt-to-valueratioof60%
K=(1–λ)Kl+λ(1-τ)i=0.40×12%+0.60×(1–0.34)×10%
K=9.6%
9Avalue-maximizingfirm’swould:
a)UndertakeaninvestmentprojectaslongastheIRRexceedstheNPV
b)UndertakeaninvestmentprojectaslongastheIRRislessthanthecostofcapital.
c)UndertakeaninvestmentprojectaslongastheIRRexceedsthecostofcapital.
d)Noneoftheabove
Answer:
c)
10Usingthenotationofthetext,theCAPMstates:
a)
b)
c)
d)Noneoftheabove
Answer:
c)
11ThecommonstockofKansasCityPowerandLighthasabetaof0.80.TheTreasurybillrateis4percentandthemarketriskpremiumis8percent.KCP&Lisinthe34%taxbracket.Whatistheircostofequitycapital?
a)12.0%
b)10.4%
c)7.20%
d)6.4%
e)8.22%
Answer:
b)
Rationale:
Equation17.2:
10.4%=4%+.8×8%
12Themarketriskpremium
a)Canbedefinedbythedifferencebetweentheexpectedmarketreturnandtherisk-freerate.
b)Istherewardforbearingnondiversifiablerisk.
c)Istheslopeofthesecuritymarketline.
d)Canbeexpressedas
e)Alloftheabovearecorrect.
Answer:
a)
13Computethedebt-to-equityratioforafirmthathasadebt-to-valueratioof60%.
a)1/3
b)2/5
c)3/2
d)2/3
e)Noneoftheabove
Answer:
c)
Rationale:
14MicroSpinoffs,Inc.,issued20-yeardebtayearagoatparvaluewithacouponrateof9percent,paidannually.Today,thedebtissellingat$1,050.Ifthefirm’staxrateis34%,whatisitsafter-taxcostofdebt?
a)9%
b)8.46%
c)5.94%
d)5.58%
e)Noneoftheabove
Answer:
d)
Rationale:
Usingafinancialcalculatortosolvefortheyieldtomaturityofthefirm’soutstandingdebtgivesthepre-taxcostofcapital.N=19;PV=–1050;PMT=90;FV=1,000;I/YR=8.46;8.46%×(1–.34)=5.58%Financestudentsshouldknowhowtodothis.Whilethisisnotexplicitlycoveredinthechapter,manyprofessorscoverthistopicinadiscussionofWACC.
15Thefirm’staxrateis34%.Thefirm’spre-taxcostofdebtis8%;thefirm’sdebt-to-equityratiois4;therisk-freerateis3%;thebetaofthefirm’scommonstockis1.5;themarketriskpremiumis9%.Whatisthefirm’scostofequitycapital?
a)33.33%
b)10.85%
c)13.12%
d)16.5%
e)Noneoftheabove
Answer:
c)
Rationale:
3%+1.5×9%=16.5%
16Systematicriskrefersto:
a)thediversifiable(companyspecific)riskofanasset
b)thenondiversifiablemarketriskofanasset
c)economicandpoliticalrisk
d)theriskthatcanbehedged
Answer:
b)
17Thefirm’staxrateis34%.Thefirm’spre-taxcostofdebtis8%;thefirm’sdebt-to-equityratiois4;therisk-freerateis3%;thebetaofthefirm’scommonstockis1.5;themarketriskpremiumis9%.Calculatetheweightedaveragecostofcapital.
a)33.33%
b)8.09%
c)9.02%
d)16.5%
e)Noneoftheabove
Answer:
b)
Rationale:
18Theformulaforbetais:
a)
b)
c)
d)
Answer:
c)
Rationale:
c)isofcoursecorrect.Answera)isincorrectsincetheCAPMusesbetatodefinetherelationshipbetweenriskandreturn,butdoesn’tdefinebeta.
CostofCapitalinSegmentedversusIntegratedMarkets
19IntheCapitalAssetPricingModel(CAPM),thetermBeta,,is:
a)ameasureofsystematicriskinherentinasecurity
b)calculatedasthe“covarianceoffuturereturnsbetweenaspecificsecurityandthemarketportfolio”dividedbythe“varianceofreturnsofthemarketportfolio”
c)a)andb)
d)noneoftheabove
Answer:
c)
20AssumethatXYZCorporationisaleveragedcompanywiththefollowinginformation:
Kl=costofequitycapitalforXYZ=13%
i=before-taxborrowingcost=8%
t=marginalcorporateincometaxrate=30%
IfXYZ’sdebt-to-total-market-valueratiois40%,thenitsweightedaveragecostofcapital,K,is:
a)8%
b)9%
c)10%
d)12%
Answer:
c)
Rationale:
Equation17.1
K=(1–0.40)×0.13+0.40×(1–0.30)×0.08
=0.60×0.13+0.40×0.70×0.08
=0.078+0.022=0.100=10%
21Formostcountriesandmostfirms,thedomesticcountrybeta
a)Canbenolowerthanitsworldbeta
b)Isnormallymuchsmallerthantheworldbeta
c)Isnormallymuchmuchhigherthantheworldbeta
d)Isexactlyequaltotheworldbeta
Answer:
a)
22SupposethedomesticU.S.betaofIBMis1.0,thatis
andthattheexpectedreturnontheU.S.marketportfoliois
=12percent,andthattheU.S.T-billrateis6percent.IftheworldbetameasureofIBMis
thenwecansay
a)ThatiftheU.S.marketsarefullyintegratedwiththerestoftheworld,IBM’scostofequitycapitalwouldbe20%lowerthanifU.S.marketsweresegmented.
b)ThatiftheU.S.marketsarefullyintegratedwiththerestoftheworld,IBM’scostofequitycapitalwouldbe10%lowerthanifU.S.marketsweresegmented.
c)ThatiftheU.S.marketsarefullyintegratedwiththerestoftheworld,IBM’scostofequitycapitalwouldbeone-thirdlowerthanifU.S.marketsweresegmented.
d)Noneoftheabove
Answer:
b)
Rationale:
23Studiessuggestthatinternationalcapitalmarketsarenotsegmentedanymore
a)Andarethereforefullyintegrated.
b)Butarenotasyetfullyintegrated.
c)Socross-listingofshareswillnotlowerafirm’scostofcapital
d)Noneoftheabove
Answer:
b)
24ComputethedomesticcountrybetaofStansfieldBicyclesaswellasitsworldbeta
CorrelationCoefficients
Stansfield
England
World
SD(%)
%
Stansfield
1.00
0.90
0.60
20
?
England
1.00
0.80
18
14
World
1.00
15
12
a)1.00and0.80respectively
b)0.80and0.00respectively
c)4.50and4.00respectively
d)Noneoftheabove
Answer:
a)
Rationale:
Theformulaforbetaisgivenby
TofindStansfield’sdomesticcountrybeta,weusedomesticmarketdata:
Thatandrecallingtheformularelatingcovarianceandcorrelation:
TofindStansfield’sworldbetadotheaboveagainwithworlddata:
25SupposethattheBritishstockmarketissegmentedfromtherestoftheworld.UsingtheCAPMandarisk-freerateof5%,estimatetheequitycostofcapitalforStansfield
CorrelationCoefficients
Stansfield
England
World
SD(%)
%
Stansfield
1.00
0.90
0.60
20
?
England
1.00
0.80
18
14
World
1.00
15
12
a)14%
b)12%
c)9%
d)Noneoftheabove
Answer:
a)
Rationale:
Forastudentwhohasdonethe
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