Lecture 8

Capital for
Multinational
Business
Multinational Business Finance
 Global Economy
 Corporate Ownership, Goal, and Governance
 International Monetary System
 Balance of Payments
 Foreign Exchange Market
 International Parity Conditions
 Foreign Exchange Forecasting
 Foreign Currency Derivatives and Swaps
 Transaction Exposure
 Translation Exposure
 Operating Exposure
 Global Cost of Capital
 Raising Capital Globally
 Multinational Tax Management
 International Trade Finance
 Foreign Direct Investments
 Multinational Capital Budgeting
 Global Cost and Availability
of Capital
• A firm that must source its long-term debt and equity in a
segmented domestic market will have a high cost of capital
and will face limited availability of capital
• Global integration of capital markets has given many firms
access to new and cheaper sources of funds beyond those
available in their home markets.
• If a firm is located in a country with illiquid, small, and/or
segmented capital markets, it can achieve this lower global
cost and greater availability of capital by a properly designed
and implemented strategy.
 Cost of Equity

• Local: CAPM
ke = krf + βj(km – krf)

• Global: ICAPM
keglobal = krfg + βjg(kmg – krfg)

• “I” stands for International

• The risk-free rate is unlikely to change much, but
beta could easily change.
 Cost of Equity for Nestle

• Local
• krf=3.3%, kM=10.2%, β=0.885
• ke=3.3+0.885 x (10.2-3.3) = 9.4065

• Global
• krf=3.3%, kM=13.7%, β=0.585
• ke=3.3+0.585 x (13.7-3.3) = 9.3840
 WACC for Trident
• Local
• krf=4.0%, kM=9.0%, β=1.20, kd=8.0%, t=35%
• E=60%, D=40%
• CAPM: ke= krf + βj(km – krf) =4.0+1.2(9.0-4.0)=10%
• WACC= E x ke + D x kd(1-t)
=0.60*10+0.40*8.0(1-0.35) = 8.08%

• Global
• kM=8.0%, β=0.90
• keg = krfg + βjg(kmg – krfg)=4.0+0.9*(8.0-4.0)=7.6%
• WACC= 0.60*7.6+0.40*8.0*(1-0.35) = 6.64%
 Inputs into ICAPM
• Riskless rate – long term government fixed income
security
• Betas – estimate using regression of stock returns
on market index, local or global; or obtain betas
from analysts or database
• Equity risk premium – forward looking estimate,
most analysts use ERP around 5%
 WACC for MNEs
• Ceteris paribus, MNEs often have …
– Lower cost of equity, lower debt (and tax shield)
– Greater investment opportunity set
• Outcome: MNEs take more projects than comparable domestic
firms, as the result MNEs’ marginal WACC may be higher than
domestic
Multinational Business Finance
 Global Economy
 Corporate Ownership, Goal, and Governance
 International Monetary System
 Balance of Payments
 Foreign Exchange Market
 International Parity Conditions
 Foreign Exchange Forecasting
 Foreign Currency Derivatives and Swaps
 Transaction Exposure
 Translation Exposure
 Operating Exposure
 Global Cost of Capital
 Raising Capital Globally
 Multinational Tax Management
 International Trade Finance
 Foreign Direct Investments
 Multinational Capital Budgeting
 Sourcing Equity Globally

• Design a strategy that will attract international investors.

– identify and choose alternative paths to access global markets.
– May have to restructure the firm, improve quality and level of
its disclosure, and make its accounting and reporting
standards more transparent to potential foreign investors
 Optimal Financial Structure
and the MNE
• The domestic theory of optimal financial structures needs to
be modified by four more variables in order to accommodate
the case of the MNE.
• These variables include:
– Availability of capital
– Diversification of cash flows
– Foreign exchange risk
– Expectations of international portfolio investors
 Cost of borrowing overseas
• US firm borrows £5,000,000 in the UK for one year at 7.375%
interest. St=0= $2.0260/£, St=1= $2.1640/£
• $ proceeds t=0= 5,000,000*2.0260 = $10,130,000
• Payable in £ = 5,000,000 x 1.07375 = £5,368,750
• Payable in $: 5,368,750*2.1640 = $11,617,975
• % in USD: 11,617,975/10,130,000 -1= 0.1469 =14.69%
• Borrowing cost in $:
(1+r$)=(1+rSFr)(1+s)
• For s see lecture 2 slide 13:
• US perspective for value of £  $/£  direct quotation
• (1+r$)= (1+0.07375)*(1+(2.1640-2.0260)/2.0260) = 1.1469
r$= 14.69%
 Cost of borrowing overseas
• US firm needs to borrow $10,000,000. It borrows in Switzerland
in SFr for 1 year at 5%. Exchange rates are as follows:
St=0=SFr1.5/$ and St=1=SFr1.44/$.
• Borrows in SFr t=0 : $10,000,000*1.5 = SFr 15,000,000
• Payable in SFr t=1 SFr 15,000,000 x 1.05 = SFr 15,750,000
• Payable in $: SFr 15,750,000/1.44 = $10,937,500
• % in USD:
10,937,500 /10,000,000-1=0.09375 =9.375%
• Borrowing cost in $: (1+r$)=(1+rSFr)(1+s)
• For s see lecture 2 slide 13:
• SFr/$  about value of SFr  indirect quote
• (1+r$)=(1+0.05)(1+(1.5-1.44)/1.44)= 1.09375
r$ = 9.375%
 Raising equity globally
• Equity Issuance
– Methods: IPO/SEO, Euroequity, Direct Issue, Private
Placement
• Equity Listings
– Methods: cross listing, depositary receipts
• Private Placements
– Methods: sale to private investors, qualified institutional
investors, private equity
 Depositary receipts and similar
structures
• Banks
– Depositary: gets money from western investors, issues
depositary receipts
– Custodian: buys local shares, informs depositary bank how
many receipts to issue
• Western investors
– Pay/receive $ for depositary receipts
• Local market participants
– Pay/receive local currency for local shares
• Brokers
– Western: process buy/sell orders
– Local: mirror western orders after getting money
 Global Registered Shares

• Issuer meets listing requirements on world’s major

exchanges and issues shares
• Results: GRS can trade 24 hours/day
• Example
• A German GRS is worth € 4/share in Frankfurt.
• Current FX rate is $1.2/€.
• In New York the same GRS will trade at
• 1.20 x €4 = $4.80
• If it were ADR tailored to US market, it would have
target price range between $10 and $20.
• If 1 ADR = 4 shares, then such ADR would trade in
New York at 4 x €4 x 1.20 = $19.20
 Raising Debt Globally

• The international debt market offers the borrower a

wide variety of different maturities, repayment
structures, and currencies of denomination.
• The markets and their many different instruments
vary by source of funding, pricing structure,
maturity, and subordination or linkage to other debt
and equity instruments.
• The three major sources of debt funding on the
international markets are bank loans, money
market, and international bond market
 Example
• A European company is borrowing US$650,000,000 via a syndicated
eurocredit for 6 years at 80 b.p. over 6 months LIBOR. Up-front
issuance fees total 1.2% of the principal. What is the effective interest
cost for the first year if LIBOR is 4.00% for the first six months and
4.20% for the second six months?

• Net$=650,000,000*(1-0.012)=$642,200,000
• Payablet=6mo=0.5*(0.040+0.008)*650,000,000 = 15,600,000
• Payablet=12mo=0.5*(0.042+0.008)*650,000,000 = 16,250,000
• EIC = (15,600,000+16,250,000)/642,200,000 = 0.049595 = 4.9595%
 Summary
• Funds from world capital markets is often cheaper than funds
from local market
• Multinationals may have higher marginal cost of capital
because they often undertake more projects than comparable
local firms
• Both equity and fixed income securities are raised
internationally