TB CH

International Financial Management, 8e (Eun)
Chapter 17 International Capital Structure and the Cost of Capital
1) The cost of capital is

A) the minimum rate of return an investment project must generate in order to pay its financing
costs.
B) the minimum rate of return an investment project must generate in order to pay its financing
costs plus a reasonable profit.
C) the maximum rate of return an investment project must generate in order to pay its financing
costs.
D) the maximum rate of return an investment project must generate in order to pay its financing
costs plus a reasonable profit.
Answer: A
Topic: Cost of Capital
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2) For a firm that has both debt and equity in its capital structure, its financing cost can be
represented by the weighted average cost of capital that is computed by
A) weighing the pre-tax borrowing cost of the firm and the cost of equity capital, using the debt
as the weight.
B) weighing the after-tax borrowing cost of the firm and the cost of equity capital, using the debt
as the weight.
C) K = (1 − λ)Kl + λ (1 − τ)i
where:
K = weighted average cost of capital
Kl = cost of equity capital for a leveraged firm
i = before-tax borrowing cost
τ = marginal corporate income tax rate
λ = debt-to-total-market-value ratio
D) weighing the after-tax borrowing cost of the firm and the cost of equity capital, using the debt
as the weight. Additionally, this may be expressed as K = (1 − λ)Kl + λ(1 − τ)i
where:
K = weighted average cost of capital
Kl = cost of equity capital for a leveraged firm
i = before-tax borrowing cost
τ = marginal corporate income tax rate
λ = debt-to-total-market-value ratio
Answer: D
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3) In the notation of the book, K = (1 − λ)Kl + λ(1 − τ)i
Which of these is correct?
A) The debt-to-equity ratio is λ
B) The tax rate is τ
C) The after-tax cost of debt capital is i
D) all of the options
Answer: B
4) In the notation of the book, K = (1 − λ)Kl + λ(1 − τ)i ; which of the following is correct?
A) The debt-to-total market value ratio is λ
B) The tax rate is i
Answer: A
B) The cost of equity capital for a levered firm is K
C) The pre-tax cost of debt capital is i
Answer: C
B) The cost of equity capital for a levered firm is Kl
Answer: B
A) The weighted average cost of capital for a levered firm is K
B) The tax rate is τ
Answer: A
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8) At the optimal capital structure,
A) K = (1 − λ)Kl + λ(1 − τ)i will be minimized.
B) The debt-equity ratio will be equal to the debt-to-value ratio.
C) K = (1 − λ)Kl + λ(1 − τ)i will be maximized.
D) none of the options
Answer: A
9) Solve for the weighted average cost of capital.
10.60% = K1 = cost of equity capital for a leveraged firm

1/3 = λ = debt-to-total-market-value ratio
8.0% = i = before-tax borrowing cost
40.0% = τ = marginal corporate income tax rate
A) 8.67 percent
B) 8.00 percent
C) 7.60 percent
D) 7.33 percent
Answer: A
Explanation: 0.0867 = 8.67% = (1 − (1/3)) (0.1060) + (1/3) (1 − 0.40) (0.08)

A) 8.67 percent
B) 8.00 percent
C) 7.60 percent
D) 7.33 percent
Answer: B
Explanation: 0.0800 = 8% = (1 − 0.50) (0.112)) + 0.50 (1 − 0.40) (0.08)
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A) 8.67 percent
B) 8.00 percent
C) 7.60 percent
D) 7.33 percent
Answer: C
Explanation: 0.0760 = 7.60% = (1 − (3/5)) (0.118) + (3/5) (1 − 0.40) (0.08)

A) 8.67 percent
B) 8.00 percent
C) 7.60 percent
D) 7.33 percent
Answer: D
Explanation: 0.0733 = 7.33% = (1 − (2/3)) (0.124) + (2/3) (1 − 0.40) (0.08)

A) 8.67 percent
B) 7.60 percent
C) 7.33 percent
D) 7.14 percent
Answer: D
Explanation: 0.0714 = 7.14% = (1 − (5/7)) (0.13) + (5/7) (1 − 0.40) (0.08)
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A) 7.00 percent
B) 6.89 percent
C) 6.73 percent
D) 6.67 percent
Answer: A
Explanation: 0.0700 = 7% = (1 − (3/4)) (0.136) + (3/4) (1 − 0.40) (0.08)

A) 7.00 percent
B) 6.89 percent
C) 6.73 percent
D) 6.67 percent
Answer: B
Explanation: 0.0689 = 6.89% = (1 − (7/9)) (0.142) + (7/9) (1 − 0.40) (0.08)

A) 7.00 percent
B) 6.89 percent
C) 6.73 percent
D) 6.67 percent
Answer: C
Explanation: 0.0673 = 6.73% = (1 − (9/11)) (0.154) + (9/11) (1 − 0.40) (0.08)
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A) 7.00 percent
B) 6.89 percent
C) 6.73 percent
D) 6.67 percent
Answer: D
Explanation: 0.0667 = 6.67% = (1 − (5/6)) (0.16) + (5/6) (1 − 0.40) (0.08)

A) 7.00 percent
B) 6.89 percent
C) 6.73 percent
D) 6.57 percent
Answer: D
Explanation: 0.0657 = 6.57% = (1 − (6/7)) (0.172) + (6/7) (1 − 0.40) (0.08)
10.60% = K1
1/3 = λ
8.0% = i
40.0% = τ
A) 8.67 percent
B) 8.00 percent
C) 7.60 percent
D) 7.33 percent
Answer: A
Explanation: 0.0867 = 8.67% = (1 − (1/3)) (0.106) + (1/3) (1 − 0.40) (0.08)
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11.20% = K1
1/2 = λ
8.0% = i
40.0% = τ
A) 8.67 percent
B) 8.00 percent
C) 7.60 percent
D) 7.33 percent
Answer: B
Explanation: 0.0800 = 8% = (1 − (1/2)) (0.112) + (1/2) (1 − 0.40) (0.08)
11.80% = K1
3/5 = λ
8.0% = i
40.0% = τ
A) 8.67 percent
B) 8.00 percent
C) 7.60 percent
D) 7.33 percent
Answer: C
Explanation: 0.0760 = 7.60% = (1 − (3/5)) (0.118) + (3/5) (1 − 0.40) (0.08)
12.40% = K1
2/3 = λ
8.0% = i
40.0% = τ
A) 8.67 percent
B) 8.00 percent
C) 7.60 percent
D) 7.33 percent
Answer: D
Explanation: 0.0733 = 7.33% = (1 − (2/3)) (0.124) + (2/3) (1 − 0.40) (0.08)
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13.00% = K1
5/7 = λ
8.0% = i
40.0% = τ
A) 8.67 percent
B) 8.00 percent
C) 7.60 percent
D) 7.14 percent
Answer: D
Explanation: 0.0714 = 7.14% = (1 − (5/7)) (0.13) + (5/7) (1 − 0.40) (0.08)
13.60% = K1
3/4 = λ
8.0% = i
40.0% = τ
A) 7.00 percent
B) 6.89 percent
C) 6.73 percent
D) 6.67 percent
Answer: A
Explanation: 0.0700 = 7% = (1 − (3/4)) (0.136) + (3/4) (1 − 0.40) (0.08)
14.20% = K1
7/9 = λ
8.0% = i
40.0% = τ
A) 7.00 percent
B) 6.89 percent
C) 6.73 percent
D) 6.67 percent
Answer: B
Explanation: 0.0689 = 6.89% = (1 − (7/9)) (0.142) + (7/9) (1 − 0.40) (0.08)
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15.40% = K1
9/11 = λ
8.0% = i
40.0% = τ
A) 7.00 percent
B) 6.89 percent
C) 6.73 percent
D) 6.67 percent
Answer: C
Explanation: 0.0673 = 6.73% = (1 − (9/11)) (0.154) + (9/11) (1 − 0.40) (0.08)
16.00% = K1
5/6 = λ
8.0% = i
40.0% = τ
A) 7.00 percent
B) 6.89 percent
C) 6.73 percent
D) 6.67 percent
Answer: D
Explanation: 0.0667 = 6.67% = (1 − (5/6)) (0.16) + (5/6) (1 − 0.40) (0.08)
17.20% = K1
6/7 = λ
8.0% = i
40.0% = τ
A) 7.00 percent
B) 6.89 percent
C) 6.73 percent
D) 6.57 percent
Answer: D
Explanation: 0.0657 = 6.57% = (1 − (6/7)) (0.172) + (6/7) (1 − 0.40) (0.08)
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29) Find the debt-to-value ratio for a firm with a debt-to-equity ratio of 1/2.
A) 1/3
B) 1/2
C) 3/5
D) 2/3
Answer: A
Explanation: DV = 1/(1 + 2) = 1/3
30) Find the debt-to-value ratio for a firm with a debt-to-equity ratio of 1.
A) 1/3
B) 1/2
C) 3/5
D) 2/3
Answer: B
Explanation: DV = 1/(1 + 1) = 1/2
31) Find the debt-to-value ratio for a firm with a debt-to-equity ratio of 1½.
A) 1/3
B) 1/2
C) 3/5
D) 2/3
Answer: C
Explanation: DV = 3/(3 + 2) = 3/5
A) 1/3
B) 1/2
C) 3/5
D) 2/3
Answer: D
Explanation: DV = 2/(2 + 1) = 2/3
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A) 1/3
B) 1/2
C) 3/5
D) 5/7
Answer: D
Explanation: DV = 5/(5 + 2) = 5/7
A) 1/3
B) 1/2
C) 3/5
D) 5/7
Answer: D
Explanation: DV = 5/(5 + 2) = 5/7
A) 3/4
B) 7/9
C) 4/5
D) 9/11
Answer: A
Explanation: DV = 3/(3 + 1) = 3/4
A) 3/4
B) 7/9
C) 4/5
D) 9/11
Answer: B
Explanation: 7/(7 + 2) = 7/9
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A) 3/4
B) 7/9
C) 4/5
D) 9/11
Answer: C
Explanation: DV = 4/(4 + 1) = 4/5
A) 3/4
B) 7/9
C) 4/5
D) 9/11
Answer: D
Explanation: 9/(9 + 2) = 9/11
A) 3/4
B) 7/9
C) 4/5
D) 5/6
Answer: D
Explanation: DV = 5/(5 + 1) = 5/6
40) Find the debt-to-equity ratio for a firm with a debt-to-total-value ratio of 1/2.
A) 1
B) 2
C) 3
D) 4
Answer: A
Explanation: Solve for equity = 1/(1 + X) = 1/2; X = 1; Thus debt-to-equity = 1/1 = 1
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A) 1
B) 2
C) 3
D) 4
Answer: B
42) Find the debt-to-equity ratio for a firm with a debt-to-total-value ratio of 3/4
A) 1
B) 2
C) 3
D) 4
Answer: C
A) 1
B) 2
C) 3
D) 4
Answer: D
A) 2
B) 3
C) 4
D) 5
Answer: D
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45) Corporations are becoming multinational not only in the scope of their business activities but
also in their capital structure(.)
A) by raising funds from domestic as well as government sources.
B) by raising funds from foreign as well as domestic sources.
C) This trend reflects not only a conscious effort on the part of firms to raise the cost of capital
by international sourcing of funds but also the ongoing liberalization and deregulation of
international financial markets that make them accessible for many firms.
D) by raising funds from foreign as well as domestic sources. This trend reflects not only a
conscious effort on the part of firms to raise the cost of capital by international sourcing of funds,
but also the ongoing liberalization and deregulation of international financial markets that make
them accessible for many firms.
Answer: B
46) Find the weighted average cost of capital for a firm that has a debt-to-equity ratio of 1½, a
tax rate of 34 percent, a levered cost of equity of 12 percent and an after-tax cost of debt of 8
percent.
A) 9.6 percent
B) 7.968 percent
C) 14 percent
Answer: A
Explanation: If DE = 3/2, then DV = 3/(3 + 2) = 3/5; 0.0960 = 9.6% = (1 − (3/5)) (0.12) + (3/5)
(0.08)
47) Find the weighted average cost of capital for a firm that has a debt-to-equity ratio of 1½, a
tax rate of 34 percent, a levered cost of equity of 12 percent and a pre-tax cost of debt of 10
percent.
A) 9.6 percent
B) 7.968 percent
C) 8.76 percent
Answer: C
(1 − 0.34) (0.08)
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48) Find the weighted average cost of capital for a firm that has a debt-to-equity ratio of 2, a tax
rate of 40 percent, a levered cost of equity of 12 percent and an after-tax cost of debt of 9
percent.
A) 7.6 percent
B) 7.968 percent
C) 10 percent
Answer: C
Explanation: If DE = 2/1, then DV = 2/(2 + 1) = 2/3; 0.1000 = 10% = (1 − (2/3)) (0.12) + (2/3)
(0.09)
49) Find the weighted average cost of capital for a firm that has a debt-to-equity ratio of 2, a tax
rate of 40 percent, a levered cost of equity of 12 percent and a pre-tax cost of debt of 9 percent.
A) 7.6 percent
B) 7.968 percent
C) 10 percent
Answer: A
(1 − 0.40) (0.09)
50) The cost of equity capital is

A) the expected return on the firm's stock that investors require.
B) frequently estimated by using the Capital Asset Pricing Model (CAPM).
C) generally considered to be a linear function of the systematic risk inherent in the security.
Answer: D
51) A reduced cost of equity capital increases the firm's value

A) through revaluation of the firm's existing cash flows from existing projects.
B) through increased investment as more projects become positive NPVs.
C) both of the options
Answer: C
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52) A value-maximizing firm would
A) undertake an investment project as long as the IRR exceeds the NPV.
B) undertake an investment project as long as the IRR is less than the cost of capital.
C) undertake an investment project as long as the IRR exceeds the cost of capital.
Answer: C
53) Using the notation of the text, the CAPM states

A) = + ( - )(1 - τ)
B) =λ + ( - )(1 - λ)
C) = + ( - )
Answer: C
54) The common stock of Kansas City Power and Light has a beta of 0.80. The Treasury bill rate
is 4 percent and the market risk premium is 8 percent. What is their cost of equity capital?
A) 12.0 percent
B) 10.4 percent
C) 7.20 percent
D) 6.4 percent
Answer: B
Explanation: 10.4% = 4% + 0.80 × 8%.
55) The market risk premium

A) can be defined by the difference between the expected market return and the risk-free rate.
B) is the reward for bearing nondiversifiable risk.
C) is the slope of the security market line.
D) can be expressed as ( - )
Answer: A
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56) Compute the debt-to-equity ratio for a firm that has a debt-to-value ratio of 60 percent.
A) 1/3
B) 2/5
C) 3/2
Answer: C
Explanation: Solve for equity = 3/(3 + X) = 3/5; X = 2; Thus debt-to-equity = 3/2
57) Compute the debt-to-total-value ratio for a firm that has a debt-to-equity ratio of 2.
A) 1/3
B) 2/5
C) 3/2
D) 2/3
Answer: D
Explanation: DV = 2/(2 + 1) = 2/3
58) Micro Spinoffs, Inc., issued 20-year debt one year ago today at par value with a coupon rate
of 9 percent, paid annually. Today, the debt is selling at $1,050. If the firm's tax rate is 34
percent, what is its after-tax cost of debt?
A) 9 percent
B) 8.46 percent
C) 5.94 percent
D) 5.58 percent
Answer: D
Explanation: Use the following inputs: N = 19; PV = −1,050; PMT = 90; FV = 1,000; This
yields I/YR = 8.46; 8.46 × (1 − 0.34) = 5.58%.
59) The firm's tax rate is 34 percent. The firm's pre-tax cost of debt is 8 percent; the firm's debt-
to-equity ratio is 4; the risk-free rate is 3 percent; the beta of the firm's common stock is 1.5; the
market risk premium is 9 percent. What is the firm's cost of equity capital?
A) 33.33 percent
B) 10.85 percent
C) 13.12 percent
D) 16.50 percent
Answer: D
Explanation: 16.5% = 3% + 1.5 × (9%)
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60) Systematic risk refers to
A) the diversifiable (company specific) risk of an asset.
B) the nondiversifiable (market) risk of an asset.
C) economic and political risk.
D) the risk that can be hedged.
Answer: B
61) The firm's tax rate is 34 percent. The firm's pre-tax cost of debt is 8 percent; the firm's debt-
to-equity ratio is 4; the risk-free rate is 3 percent; the beta of the firm's common stock is 1.5; the
market risk premium is 9 percent. Calculate the weighted average cost of capital.
A) 33.33 percent
B) 8.09 percent
C) 9.02 percent
D) 16.5 percent
Answer: B
Explanation: 0.0809 = 8.09% = (1/4) (16.5% ) + (3/4) (1 − 0.34) (0.08)
62) The formula for beta is
A) =
B) =
C) =
D) =
Answer: C
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63) In the Capital Asset Pricing Model (CAPM), the term Beta, β, is
A) a measure of systematic risk inherent in a security.
B) calculated as the "covariance of future returns between a specific security and the market
portfolio" divided by the "variance of returns of the market portfolio."
C) a measure of systematic risk inherent in a security; calculated as the "covariance of future
returns between a specific security and the market portfolio" divided by the "variance of returns
of the market portfolio."
Answer: C
Topic: Cost of Capital in Segmented versus Integrated Markets
64) Assume that XYZ Corporation is a levered company with the following information:
Kl = cost of levered equity capital for XYZ = 13 percent

i = before-tax borrowing cost = 8 percent
t = marginal corporate income tax rate = 30 percent
If XYZ's debt-to-total-market-value ratio is 40 percent, then its weighted average cost of capital,
K, is
A) 8 percent.
B) 9 percent.
C) 10 percent.
D) 12 percent.
Answer: C
Explanation: 0.1000 = 10% = (1 − 0.40) × (0.13) + (0.40) (1 − 0.30) (0.08)
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65) In the graph,
A) Kl and Kg represent, respectively, the cost of capital under international and local capital
structures; IRR represents the internal rate of return on investment projects; Il and Ig represent,
respectively, the optimal investment outlays under the alternative capital structures.
B) Kl and Kg represent, respectively, the cost of capital under local and international capital
structures; IRR represents the internal rate of return on investment projects; Il and Ig represent
the optimal investment outlays under the alternative capital structures.
C) both of the options
Answer: B
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66) Suppose that the firm's cost of capital can be reduced from Kl under the local capital
structure to Kg under an internationalized capital structure. The take-away lesson from the graph
is that
A) the firm can then increase its profitable investment outlay from Il to Ig, contributing to the
firm's value.
B) a reduced cost of capital increases the firm's value not only through increased investments in
new projects but also through revaluation of the cash flows from existing projects.
C) Kl and Kg represent, respectively, the cost of capital under local and international capital
structures; IRR represents the internal rate of return on investment projects; Il and Ig represent
the optimal investment outlays under the alternative capital structures.
Answer: A
67) For a firm confronted with a fixed schedule of possible new investments, any policy that
lowers the firm's cost of capital will increase the profitable capital expenditures the firm takes on
and increase the wealth of the firm's shareholders. One such policy is
A) internationalizing the firm's capital budgeting opportunities.
B) internationalizing the firm's cost of capital.
C) investing in riskier projects financed with debt.
Answer: B
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68) For most countries and most firms, the domestic country beta
A) can be no lower than its world beta.
B) is normally much smaller than the world beta.
C) is normally much higher than the world beta.
D) is exactly equal to the world beta.
Answer: A
69) Suppose the domestic U.S. beta of IBM is 1.0, that is = 1.0, and that the expected
return on the U.S. market portfolio is = 12 percent, and that the U.S. T-bill rate is 6
percent. If the world beta measure of IBM is = 0.80 then we can say
A) that if the U.S. markets are fully integrated with the rest of the world, IBM's cost of equity
capital would be 20 percent lower than if U.S. markets were segmented.
B) that if the U.S. markets are fully integrated with the rest of the world, IBM's cost of equity
capital would be 10 percent lower than if U.S. markets were segmented.
C) that if the U.S. markets are fully integrated with the rest of the world, IBM's cost of equity
capital would be one-third lower than if U.S. markets were segmented.
Answer: B
70) Studies suggest that international capital markets are not segmented anymore
A) and are therefore fully integrated.
B) but are not as yet fully integrated.
C) so cross-listing of shares will not lower a firm's cost of capital.
Answer: B
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71) Compute the domestic country beta of Stansfield Bicycles as well as its world beta.
Correlation Coefficients
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) 1.00 and 0.80 respectively
B) 0.80 and 0.00 respectively
C) 4.50 and 4.00 respectively
Answer: A
Explanation: 0.90 = X / [(0.202) × (0.182)]0.5; X = 0.0324; 0.0324 / 0.182 = 1. Next, 0.60 = X /
[(0.202) × (0.152)]05.; X = 0.018; 0.018 / 0.152 = 0.80.
72) Suppose that the British stock market is segmented from the rest of the world. Using the
CAPM and a risk-free rate of 5 percent, estimate the equity cost of capital for Stansfield.
Stansfield 1.00 0.90 0.60 20 ?
England 1.00 0.80 18 14
World 1.00 15 12
A) 14 percent
B) 12 percent
C) 9 percent
Answer: A
Explanation: 0.90 = X / [(0.202) × (0.182)]0.5; X = 0.0324; 0.0324 / 0.182 = 1. Next, solve for
X: 14% = 5% + 1(X − 5%), where X = 14% / Thus, 14% = 5% + 1(14% − 5%).
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73) Suppose that the British stock market is integrated with the rest of the world and Stansfield
Company has made its shares tradable internationally via cross-listing on the NYSE. Using the
CAPM and a risk-free rate of 5 percent, estimate the equity cost of capital for Stansfield.
Stansfield 1.00 0.90 0.60 20 ?
England 1.00 0.80 18 14
World 1.00 15 12
A) 12 percent
B) 10.60 percent
C) 6.60 percent
D) None of the options
Answer: A
Explanation: 0.60 = X / [(0.202) × (0.152)]05.; X = 0.018; 0.018 / 0.152 = 0.80. Next, solve for
X: 12% = 5% + 1(X − 5%), where X = 12%. Thus, 10.60% = 5% + 0.80 (12% − 5%).
74) Assume that XYZ Corporation is a leveraged company with the following information:
Kl = cost of equity capital for XYZ = 13 percent

If XYZ's debt-to-total-market-value ratio is 40 percent, then its weighted average cost of capital,
K, is:
A) 8 percent
B) 9 percent
C) 10 percent
D) 12 percent
Answer: C
Explanation: 0.1000 = 10% = (1 − 0.40) × (0.13) + (0.40) (1 − 0.30) (0.08)
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75) Assume that XYZ Corporation is a leveraged company with the following information:
Kl = cost of equity capital for XYZ = 13 percent

Calculate the debt-to-total-market-value ratio that would result in XYZ having a weighted
average cost of capital of 9.3 percent.
A) 35 percent
B) 40 percent
C) 45 percent
D) 50 percent
Answer: D
Explanation: 0.0930 = (1 − X) (0.13) + X (1 − 0.30) (0.08); Solving for X = 50%
76) Assume that the risk-free rate of return is 4 percent, and the expected return on the market
portfolio is 10 percent. If the systematic risk inherent in the stock of ABC Corporation is 1.80,
using the Capital Asset Pricing Model (CAPM) calculate the expected return of ABC.
A) 14.0 percent
B) 14.8 percent
C) 16.0 percent
D) 16.8 percent
Answer: B
Explanation: 0.0148 = 14.8% = 4% + 1.8 (10% − 4%)
77) In the real world, does the cost of capital differ among countries?
A) Yes
B) No
Answer: A
Topic: Does the Cost of Capital Differ among Countries?
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78) Recent studies suggest that agency costs of managerial discretion are lower in Japan than in
the United States. This suggests that
A) the cost of capital can be lower in Japan than the United States, but only if international
financial markets are not fully integrated.
B) the cost of capital can be lower in Japan than the United States, even if international financial
markets are fully integrated.
C) the cost of capital will be higher in Japan than the United States, even if international
financial markets are fully integrated.
Answer: B
Topic: Does the Cost of Capital Differ among Countries?
79) The following is an outline of certain potential benefits as well as costs associated with the
cross-border listings of stocks:
(i) the company can expand its potential investor base

(ii) issues involving the disclosure and listing requirements
(iii) creates a secondary market for the company's shares
(iv) volatility spillover from the overseas markets
(v) liquidity
(vi) control of the company by foreigners
(vii) enhances the visibility of the company's name and its products in foreign marketplaces
Which of the following represent all the potential benefits of the cross-border listings of stocks?
A) (i), (ii), and (iii)
B) (ii), (iv), and (vi)
C) (i), (iii), (v), and (vii)
D) (iv), (v), (vi), and (vii)
Answer: C
Topic: CASE APPLICATION: Novo Industri; Cross-Border Listings of Stocks; International
Finance in Practice: The U.S. Welcomes the Alien Invasion
26
80) The following is an outline of certain potential benefits as well as costs associated with the
cross-border listings of stocks:
(i) the company can expand its potential investor base

(ii) issues involving the disclosure and listing requirements
(iii) creates a secondary market for the company's shares
(iv) volatility spillover from the overseas markets
(v) liquidity
(vi) control of the company by foreigners
(vii) enhances the visibility of the company's name and its products in foreign marketplaces
Which of the following represent all the potential costs of the cross-border listings of stocks?
A) (i), (ii), and (iii)
B) (ii), (iv), and (vi)
C) (i), (iii), (v), and (vii)
D) (iv), (v), (vi), and (vii)
Answer: B
Topic: CASE APPLICATION: Novo Industri; Cross-Border Listings of Stocks; International
Finance in Practice: The U.S. Welcomes the Alien Invasion
81) A firm may cross-list its share to

A) establish a broader investor base for its stock.
B) establish name recognition in foreign capital markets, thus paving the way for the firm to
source new equity and debt capital from investors in different markets.
C) expose the firm's name to a broader investor and consumer groups.
Answer: D
Topic: Capital Asset Pricing under Cross-Listings
82) Companies domiciled in countries with weak investor protection can reduce agency costs
between shareholders and management
A) by moving to a better county.
B) by listing their stocks in countries with strong investor protection.
C) by voluntarily complying with the provisions of the U.S. Sarbanes-Oxley Act.
D) having a press conference and promising to be nice to their investors.
Answer: B
27
83) Benetton, an Italian clothier, is listed on the New York Stock Exchange.
A) This decision provides their shareholders with a higher degree of protection than is available
in Italy.
B) This decision can be a signal of the company's commitment to shareholder rights.
C) This may make investors both in Italy and abroad more willing to provide capital and to
increase the value of the pre-existing shares.
Answer: D
84) In the real world, many firms that have cross-listed their shares on the U.S. markets have
experienced a reduction in the cost of capital. This effect was greater for
A) Australian firms than for Canadian firms.
B) United States firms than for Mexican firms.
C) bonds than for stocks.
Answer: A
85) To maximize the benefits of partial integration of capital markets

A) a country should choose to internationally cross-list those assets that are least correlated with
the domestic market portfolio.
B) a country should choose to internationally cross-list those assets that are most highly
correlated with the domestic market portfolio.
C) a country should choose to internationally cross-list those assets that are uncorrelated with the
domestic market portfolio.
Answer: B
86) One explanation for foreign equity ownership restrictions

A) is to make it difficult or impossible for foreigners to gain control of a domestic company.
B) is to expropriate wealth from domestic shareholders.
C) is the arguments in favor of free trade.
Answer: A
Topic: The Effect of Foreign Equity Ownership Restrictions
28
87) One likely effect of a company or government instituting foreign equity ownership
restrictions is
A) a decrease in domestic stock prices.
B) an increase in domestic stock prices.
C) a transfer of wealth from international shareholders to domestic shareholders.
Answer: A
Topic: The Effect of Foreign Equity Ownership Restrictions
88) The pricing-to-market phenomenon

A) describes the potential effect of foreign equity ownership restrictions.
B) describes the premium or discount faced by foreign shareholders relative to domestic
investors in the price of a stock due to legal restrictions imposed on foreign equity ownership.
C) was evidenced in the relative prices of Nestlé shares prior to November 17, 1988.
Answer: D
Topic: Pricing-to-Market Phenomenon
89) The Nestlé episode shows

A) that political risk can exist in a country like Switzerland, long considered a haven from such
risk.
B) the pricing to market phenomenon exists.
C) it is possible to expropriate wealth from one group of shareholders and transfer it to another
group.
Answer: D
Topic: CASE APPLICATION: Nestle
29
90) The majority of publicly traded Swiss corporations have up to three classes of common
stock:
1. Registered stock
2. Voting bearer stock
3. Nonvoting bearer stock
Until 1989, foreigners were not allowed to buy registered stocks. In the case of Nestlé this had
the effect of
A) distorting the prices of registered stock downward.
B) distorting the prices of registered stock upward.
C) this had no effect on prices.
Answer: A
Topic: CASE APPLICATION: Nestle
91) With regard to the financial structure of a foreign subsidiary,

A) using local financing can reduce political risk.
B) a MNC that finances a foreign investment with home-country equity faces greater risk of
expropriation than if it had financed the investment with at least some local debt or equity.
C) there may be advantages other than a reduction in political risk that encourage MNCs to
finance foreign subsidiaries with local money.
Answer: D
Topic: The Financial Structure of Subsidiaries
92) With regard to the financial structure of a foreign subsidiary

A) one option is to conform to the parent company's capital structure.
B) one option is to conform to the local norm of the country where the subsidiary operates.
C) one option is to vary judiciously to capitalize on opportunities to lower taxes, reduce
financing costs and risks, and take advantage of market imperfections.
Answer: D
30
93) When the parent company is fully responsible for the subsidiary's obligations,
A) the independent financial structure of the subsidiary is irrelevant.
B) potential creditors will examine the parent's overall financial condition, not the subsidiary's.
C) the independent financial subsidiary can have the same capital structure as the parent.
Answer: D
94) A recent study of MNCs suggests that when a foreign subsidiary's obligations cannot be met
with locally generated revenues,
A) parent firms bail out their subsidiaries regardless of circumstances.
B) that parent firms routinely allow subsidiaries to default.
C) most subsidiaries are financed almost entirely with banker's acceptances.
Answer: A
95) When the choice of financing a foreign subsidiary is between external debt and equity
financing
A) political risk considerations tend to favor the latter.
B) political risk considerations tend to favor the former.
C) political risk is separate from financial risk and so does not enter into a discussion of debt
equity ratios.
Answer: B
96) When the choice of financing a foreign subsidiary is between external debt and equity
financing
A) many host governments tolerate the repatriation of funds in the form of interest much better
than dividends.
B) debt financing is generally secured from the World Bank, but only in developed countries.
C) many host governments tolerate the repatriation of funds in the form of dividends much better
than interest.
Answer: A
31
97) The parent company should decide the financing method for its own subsidiaries
A) with a view toward minimizing the parent's overall cost of capital.
B) by copying the norms of the host country.
C) with a view toward gaming the bankruptcy system of the host country.
Answer: A
98) The required return on equity for a levered firm is 10.60 percent. The debt to equity ratio is
1/2, the tax rate is 40 percent, the pre-tax cost of debt is 8 percent. Find the cost of capital if this
firm were financed entirely with equity.
A) 10 percent
B) 12 percent
C) 8.67 percent
Answer: A
Explanation: 10.60 percent = X + 1/2 (X − 8) (1 − 0.40); X = 10 percent
99) The required return on equity for an all-equity firm is 10.0 percent. They are considering a
change in capital structure to a debt-to-equity ratio of 1/2, the tax rate is 40 percent, the pre-tax
cost of debt is 8 percent. Find the new cost of capital if this firm changes capital structure.
A) 14.93 percent
B) 8.67 percent
C) 7.40 percent
Answer: B
100) The required return on equity for an all-equity firm is 10.0 percent. They currently have a
beta of one and the risk-free rate is 5 percent and the market risk premium is 5 percent. They are
considering a change in capital structure to a debt-to-equity ratio of 1/2, the tax rate is 40
percent, the pre-tax cost of debt is 8 percent. Find the beta if this firm changes capital structure.
A) 1.12 percent
B) 1 percent
C) 7.4 percent
Answer: B
32

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International Financial Management, 8e (Eun)

Chapter 17 International Capital Structure and the Cost of Capital

1) The cost of capital is

9) Solve for the weighted average cost of capital.

10.60% = K1 = cost of equity capital for a leveraged firm

10) Solve for the weighted average cost of capital.

11.20% = K1 = cost of equity capital for a leveraged firm

11.80% = K1 = cost of equity capital for a leveraged firm

12) Solve for the weighted average cost of capital.

12.40% = K1 = cost of equity capital for a leveraged firm

13) Solve for the weighted average cost of capital.

13.00% = K1 = cost of equity capital for a leveraged firm

13.60% = K1 = cost of equity capital for a leveraged firm

15) Solve for the weighted average cost of capital.

14.20% = K1 = cost of equity capital for a leveraged firm

16) Solve for the weighted average cost of capital.

15.40% = K1 = cost of equity capital for a leveraged firm

16.00% = K1 = cost of equity capital for a leveraged firm

18) Solve for the weighted average cost of capital.

17.20% = K1 = cost of equity capital for a leveraged firm

19) Solve for the weighted average cost of capital.

21) Solve for the weighted average cost of capital.

22) Solve for the weighted average cost of capital.

24) Solve for the weighted average cost of capital.

25) Solve for the weighted average cost of capital.

27) Solve for the weighted average cost of capital.

28) Solve for the weighted average cost of capital.

50) The cost of equity capital is

51) A reduced cost of equity capital increases the firm's value

53) Using the notation of the text, the CAPM states

55) The market risk premium

62) The formula for beta is

Kl = cost of levered equity capital for XYZ = 13 percent

Kl = cost of equity capital for XYZ = 13 percent

Kl = cost of equity capital for XYZ = 13 percent

(i) the company can expand its potential investor base

(i) the company can expand its potential investor base

81) A firm may cross-list its share to

85) To maximize the benefits of partial integration of capital markets

86) One explanation for foreign equity ownership restrictions

88) The pricing-to-market phenomenon

89) The Nestlé episode shows

91) With regard to the financial structure of a foreign subsidiary,

92) With regard to the financial structure of a foreign subsidiary

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