Multinational Financial Management

The Cost of Capital for Foreign Investments

Traders and other undertakers may, no doubt, with great propriety, carry on a very considerable part of their projects with borrowed money. In justice to their creditors, however, their own capital ought to be, in this case, sufficient to ensure, if I may say so, the capital of those creditors; or to render it extremely improbable that those creditors should incur any loss, even though the success of the project should fall very short of the expectations of the projectors.

ADAM SMITH (1776)

LEARNING OBJECTIVES

• To determine the cost of capital for foreign investments and identify those circumstances under which that cost should be higher, lower, or the same as that for comparable domestic projects
• To identify and address the key issues involved in applying the capital asset pricing model to estimate the cost of capital for foreign projects
• To illustrate the impact of globalization on the cost of capital
• To calculate the effective dollar costs of foreign currency borrowing taking into account interest rates exchange rate changes and taxes
• To identify the relevant factors and trade-offs in establishing a company's worldwide capital structure
• To calculate the value of below-market financing opportunities

A central question for the multinational corporation is whether the required rate of return on foreign projects should be higher, lower, ...