This includes answers to all the essay questions on this module. Essays are of a very high quality, well written and very referenced. Essays have not been submitted. I scored one of the highest grades in the class for this module. The essays are answering previous exam questions and were prepared i...
BSC019
Explain why WACC may be different for MNCs in comparison to local firms.
How do managers estimate the World CAPM? (40 marks)
A firm´s WACC is the product of its cost of equity and cost of debt and their respective weights added together.
Therefore, for WACC to differ for MNCs in comparison to local companies, there must be discrepancies in both
types of firms´ cost of equity or cost of debt, or both. On paper, any firm, independently of its origin could sell its
shares or bonds in any market and borrow from any bank. However, in reality, the proximity of a firm´s operations
to its sources of finance can significantly influence its cost-effectiveness (Jung, 2017). This essay will explore how
this and other outcomes of geographical expansion can ultimately affect a firm's cost of capital.
For the average publicly traded MNC in US exchanges earnings from foreign operations represent 40% of its total
earnings (McKinsey, 2017). As different countries tend not to have their economies perfectly synchronized and can
be exposed to different country-specific shocks a firm with foreign exposure can benefit from diversification
effects, reducing the overall volatility of its earnings. Fatemi´s (1984) study comparing the performance of a
portfolio of MNCs against a portfolio of purely domestic firms supports this claim by showing that returns for the
MNC portfolio fluctuated less. The effect of this lower level of risk can be illustrated by the Capital Asset Pricing
Model (CAPM), which attempts to determine the theoretical expected return on assets by building on principles of
modern portfolio theory by Harry Markowitz (1959). The CAPM implies that an asset´s expected return is linearly
related to its sensitivity to systemic risk, quantified by its beta. As the performance of an MNC is less correlated to
the domestic market performance than an otherwise equal local firm it will have a lower betta and therefore a lower
cost of equity capital.
On the other side, it could be argued that due to greater integration in the world's markets it would be more
appropriate to use a global market to calculate the risk premium and betta of companies. If this were the case
MNCs would not necessarily benefit from lower a lower cost of equity capital as a lower correlation with the
domestic market would no longer be relevant and local firms could even benefit from lower bettas. However, for
this to be applicable it would be necessary for investors to have equal access to all equities around the world. This
does not seem to be supported by current evidence, as Weisbach (2006) reports that only 12% of equity issues
are financed by non-national sources. Further, MNCs seem to have an advantage when raising money abroad as
international issues tend to be done by cross-listing on foreign exchanges which tend to be more frequent for
MNCs (Doidge et al.,2009). Moreover, foreign ownership also tends to increase with operations abroad (Ferreira
and Matos, 2008). This is exemplified by the fact that foreign ownership of domestic US firms is only 4%
compared to 8.4% for MNCs. For this reason, it is most likely the global CAPM is not appropriate for either type of
company, even less so for local companies.
While the CAPM offers a useful illustration of the effects of diversifications due to the model´s underlying
assumptions it ignores other factors present in the real world. Investors do not have access to all available
information which causes an information asymmetry between investors in different countries. Being closer to a firm
The benefits of buying summaries with Stuvia:
Guaranteed quality through customer reviews
Stuvia customers have reviewed more than 700,000 summaries. This how you know that you are buying the best documents.
Quick and easy check-out
You can quickly pay through credit card or Stuvia-credit for the summaries. There is no membership needed.
Focus on what matters
Your fellow students write the study notes themselves, which is why the documents are always reliable and up-to-date. This ensures you quickly get to the core!
Frequently asked questions
What do I get when I buy this document?
You get a PDF, available immediately after your purchase. The purchased document is accessible anytime, anywhere and indefinitely through your profile.
Satisfaction guarantee: how does it work?
Our satisfaction guarantee ensures that you always find a study document that suits you well. You fill out a form, and our customer service team takes care of the rest.
Who am I buying these notes from?
Stuvia is a marketplace, so you are not buying this document from us, but from seller 1111stClass. Stuvia facilitates payment to the seller.
Will I be stuck with a subscription?
No, you only buy these notes for $71.62. You're not tied to anything after your purchase.
