Question

What are the components of the weighted average cost of capital (WACC) and how do they differ for an MNE compared to a purely domestic firm?

There are potential benefits and risks from raising capital on global markets. Discuss the pros and cons in terms of risk of raising capital on global markets.

Briefly discuss and explain the global CAPM.

Answer 1

Components of WACC are:

1. Cost of Equity (ke)

2. Cost of Debt (kd)

3. Cost of Preference Share (kp)

WACC = (w​​​​​​e*ke) + (w​​​​​​d*k​​​​​​d)(1-T) + (w​​​​​​p*k​​​​​​p)

In case of MNCs, the parent company is in one country and the subsidiaries are in various other countries. The question arises, if WACC should be seen from the perspective of parent company or the subsidiaries. Basically, the total effect from the cash flows has to be seen from the perspective of investors in the parent company.

The pros and cons in terms of risk of raising capital on global markets are:

Pros:

1. Foreign money flowing into your economy

2. International recognition of the company as a brand

Cons:

1. Expensive

2. High transaction costs

3. Exchange rate risk (Currency Volatility)

4. Liquidity Risks

5. Part of ownership going to other countries

The global capital asset pricing model is a financial model that extends the concept of the CAPM to international investments. The standard CAPM pricing model is used to help determine the return investors require for a given level of risk. When looking at investments in an international setting, the global version of the CAPM model is used to incorporate foreign exchange risks (typically with the addition of a foreign currency risk premium) when dealing with several currencies.