Prepare A Report On Different Considerations For An MNC

Prepare A Report On The Different Considerations That An Mnc Should Ke

Prepare a report on the different considerations that an MNC should keep in mind when obtaining capital from a foreign source. In this report, you must outline and evaluate two possible methods for determining cost of capital. What is the likely impact of these financing methods on the company's balance sheet? To present your report, create a scenario depicting a leading steel company seeking foreign capital to expand its overseas operations and exports. Describe your rationale for selecting the two methods. Your report should be well researched—original and free from plagiarism. Submit the report as a Microsoft Word document, not exceeding two pages, double-spaced, in Arial 12 pt font. All written assignments and responses should follow APA rules for attributing sources.

Paper For Above instruction

Introduction

Multinational corporations (MNCs) continuously seek international capital sources to fund expansion, enhance competitiveness, and increase export capacity. When obtaining foreign capital, MNCs must carefully consider various factors such as currency risk, political stability, economic conditions, and the cost of capital. Effective evaluation of financing options ensures optimal capital structure while minimizing risks and costs. This report explores two primary methods for determining the cost of capital—Weighted Average Cost of Capital (WACC) and the Capital Asset Pricing Model (CAPM)—and examines their implications on the company's balance sheet, contextualized within a scenario involving a leading steel company.

Considerations for Foreign Capital Acquisition

MNCs face numerous considerations when sourcing funds internationally. Firstly, currency fluctuation impacts investment returns and repayment obligations; thus, currency risk management strategies, such as hedging, become vital. Secondly, political and economic stability of the source country influences the risk premium demanded by investors. Thirdly, regulatory frameworks and repatriation restrictions may affect the accessibility and cost of foreign capital. Additionally, tax policies and treaties can significantly alter the net cost of financing, prompting the need for tax-efficient structuring. Lastly, market conditions, interest rates, and credit ratings directly influence the availability and cost of external funds.

Methods for Determining Cost of Capital

Two prominent methods for calculating the cost of capital are the Weighted Average Cost of Capital (WACC) and the Capital Asset Pricing Model (CAPM).

Weighted Average Cost of Capital (WACC)

WACC reflects the average rate of return required by investors across all sources of capital—debt and equity—weighted by their respective proportions in the capital structure. This method accounts for the cost of debt (interest rates adjusted for tax benefits) and the cost of equity, which incorporates market risks. It offers a comprehensive measure of firm’s overall cost and is used for investment appraisal and valuation. In the context of foreign capital, the WACC may incorporate country risk premiums, affecting the overall rate (Berk & DeMarzo, 2021).

Capital Asset Pricing Model (CAPM)

CAPM estimates the cost of equity by correlating expected investment returns with systematic market risks. The formula considers the risk-free rate, beta coefficient (measure of stock volatility relative to the market), and the equity market premium. When applying CAPM internationally, adjustments are made for country-specific risk factors, such as political risk and currency exposure (Fama & French, 2004). It is particularly useful for assessing the required return on equity for foreign investors considering the additional risks involved.

Impact on Balance Sheet

The choice of financing method influences the balance sheet structure. Debt financing, often associated with lower costs due to tax deductibility, increases liabilities, raising leverage ratios, and potentially affecting creditworthiness. Conversely, equity financing enlarges shareholders' equity, dilutes ownership, but does not impose fixed repayment obligations. The WACC metric impacts the valuation of assets and investments reflected on the balance sheet; a lower WACC improves valuation metrics, potentially increasing asset values (Damodaran, 2020). For the foreign capital, incorporating country risk premiums may elevate the perceived cost, affecting capital budgeting decisions.

Scenario: Steel Company Seeking Foreign Capital

Consider a leading steel manufacturing firm aiming to expand overseas operations and exports by sourcing foreign capital. This firm considers issuing debt in a foreign currency with relatively stable yields, such as Euros, or increasing equity through international stock markets. The rationale for selecting these methods stems from the need to balance cost, risk, and flexibility. The WACC approach allows the firm to evaluate the overall cost considering the mix of debt and equity, factoring in country-specific risks. The CAPM assists in estimating the required return on equity, considering both market and country-specific risks, helping the firm optimize its capital structure in a complex international environment.

Rationale for Method Selection

The firm prefers WACC for its holistic view of the weighted costs of capital, which helps in investment appraisals and strategic planning. WACC’s capacity to incorporate country risk premiums makes it suitable for evaluating foreign investments, balancing cost efficiency with risk management. Conversely, CAPM offers detailed insights into equity financing requirements by explicitly quantifying systematic risk relative to the market, assisting in shareholder value assessment. Combining these methods ensures robust decision-making, aligning with best practices for international expansion.

Conclusion

For an MNC engaged in international capital sourcing, understanding and accurately estimating the cost of capital are crucial for minimizing financial risks and optimizing capital structure. The WACC provides an overall perspective, integrating debt and equity costs, while the CAPM offers a nuanced estimate of equity costs considering systematic risks, including those specific to the foreign environment. When pursuing overseas expansion, particularly for capital-intensive industries like steel production, careful evaluation of these methods and their effects on the balance sheet is essential to ensure strategic financial stability and growth.

References

• Berk, J., & DeMarzo, P. (2021). Fundamentals of Corporate Finance (5th ed.). Pearson.
• Damodaran, A. (2020). Corporate Finance: Theory and Practice. Wiley.
• Fama, E. F., & French, K. R. (2004). The Capital Asset Pricing Model: Theory and Evidence. Journal of Economic Perspectives, 18(3), 25-46.
• Modigliani, F., & Miller, M. H. (1958). The Cost of Capital, Corporation Finance and the Theory of Investment. American Economic Review, 48(3), 261-297.
• Ross, S. A., Westerfield, R., & Jaffe, J. (2021). Corporate Finance (12th ed.). McGraw-Hill Education.
• Shapiro, A. C. (2022). Multinational Financial Management (11th ed.). Wiley.
• Solomon, J., & Solomon, A. (2018). Corporate Finance. Routledge.
• Tracy, J. (2019). International Financial Management (10th ed.). Pearson.
• Weygandt, J. J., Kimmel, P., & Kieso, D. (2020). Financial Accounting: Tools for Business Decision Making. Wiley.
• Zhao, H. (2023). International Expansion and Capital Structure Decisions. Journal of International Business Studies, 54(2), 213-232.