Question

1. Discuss the major differences between the cost of capital for a domestic firm compared to an MNC. Should an MNC have a lower or higher cost of capital than their domestic counterpart?

Answer 1

There are significant differences in cost of capital for MNC firms and domestic firms. There are various factors which are in favor of MNC's to garner funds as compared to domestic firms. Some of the factors are as follows:

• Scale of operations: Due to large scale of operations, MNC's have a privilege as compared domestic firms. They are able to raise funds through stocks and bonds very easily and with lower cost as compared to domestic companies.
• Access to international capital markets: A MNC would be having access to international capital and money market for the purpose of raising funds and at a interest rates which would be way less than the rate of interest for domestic companies. This allows them to reduce their WACC to least possible in an efficient manner. A key example can be The Coca Cola Company, which is having diversified business operations around the world and therefore they have access to financial markets of various countries where funds can be available at a very affordable interest rate to them. On the other hand, domestic companies will have to rely on the state of economy in the country and the prevailing interest rate for getting capital from the market.
• International Diversification: MNC's are in a better position to reduce their cost of capital due to their diversified business operations around the world in an effective manner. This is because a MNC's sales or cash inflow will be pouring in from different countries and reliance on a particular economy will be less therefore it will reduce risk and hence cost of capital for them in the longer run.

Having said that, there are certain disadvantages also that a MNC faces because of its diversified business operations, due to which their cost of capital may rise and the same disadvantages will be advantages for a domestic firm over time. Some of the disadvantages includes exposure to exchange rate risk, if money will be borrowed in foreign currency the change in exchange rate can have a considerable impact on the overall cost of capital for MNC as compared domestic company. Also investing in a foreign country poses more cultural, political and financial risk as compared to investing in domestic country and hence cost of capital will increase for such investments.

After the above discussion, it can be concluded that a domestic firm must have some advantage over its MNC competitors, or else it will be Monomoply of MNC in different countries around the world. Therefore, cost of capital should be lower for domestic firms as compared to MNC's in the longer run.