Question

The principles of Capital Budgeting seem to be universal. So why do we have a whole chapter on International Capital Budgeting? The Cost of Capital differs between different companies. Does the Cost of Capital differ between different countries?

Answer 1

Cost of capital refers to the cost of raising funds for the company. The sources of capital includes common stock, preferred stock, bonds , retained earnings and so on. These costs are different for different firms and different in different countries. This is due to the exposure of companies and countries to various risks and upto different extent as compared to others.

For example:- A company having huge amount of debt and trying to fund its further investment through additional debt, would makes its company more risky. This decision is only effective to certain point. Once the point is breached, not only cost of debt but also the cost of equity increases due to increase the risk the firm and its assets are exposed to because of further issuance of debt.

Two companies can also have different cost of capital due to the credit rating , brand value , reputation, performance and so on. These factors affect the cost of capital of companies and make it different form each other.

When it comes to country level, there are various macro factors like inflation, interest rates , unemployment rate, which affects the financial situations of the the countries, and eventually affects the companies of the countries. For example:- A country having high inflation will increase the interest rate in the country, leading to increase in the cost of debt of the company of that country and vice versa.