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Running Head: COST OF CAPITAL
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COST OF CAPITAL

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Cost of Capital

Melissa Isaak

Argosy University

The main objective of a Multinational Corporation (MNC) is to maximize the shareholders
wealth. The cost of capital of the MNC should therefore be minimized for the firm to realize its objectives of maximizing profits and maximizing
the shareholders wealth. To determine the cost of capital, two main methods are of importance;
the cost of equity and the cost of debt. A Multinational Corporation,
such as a steel mill has presence
in different countries, meaning access to wider international money markets (Sinha P.
and
Sinha S., 2008). When obtaining capital from a foreign source for the purpose of expansion of its
overseas operations, a large amount of capital is involved. This means that obtaining the capital involves a big risk and
is important for the MNC to consider a number of factors which influence the corporations’ cash flows
and earnings per share (EPS).

The MNC should keep in mind the borrowing cost in a particular currency. When the cost of capital is calculated,
using the cost of debt before tax adjustment method;
dividing the value of interest on loan with the amount of principle, it should be done using a stable currency. When borrowing from a country which
has a currency with a low value, a high cost of capital may be incurred. A high cost may be incurred
and noticed when converting the currency into the firm’s mother county’s currency; a huge sum of money is lost due to foreign exchange risk. The foreign exchange loss is as
a result of a currency being lesser valued when compared against a certain
currency (Sinha P. and Sinha S., 2008). The MNC’s management should therefore make sure that the right calculations are made to avoid the costs associated with foreign exchange. All the calculations should be done using the more stable currency.

The firm should keep in mind the exchange risk of the MNC, which might come up as a result of the firm’s exposure in
different currencies with regard to the credits and the
debits. When the MNC borrows the capital, it should ensure that it repays using the same currency used when borrowing. When lending it,
should ensure that the money is returned using the value of the currency it used.

The MNC’s
should also consider the acceptable level of risk. It should operate on risk levels acceptable to the management of the MNC
. When borrowing, there are risks involved in the form of source of capital. The MNC should have an acceptable level of risk, which when exceeded, the firm should not undertake
. The risk involved should be that which
when incurred, still allows room for loss cover and continue with the firms

operations.

The availability of tools for hedging is also an important consideration to be made by the MNC obtaining capital from foreign sources. The availability of hedging tools safeguards the MNC’s funds against the risk of price fluctuations (Siddaiah, 2009). The MNC should therefore obtain funds in countries with available tools for hedging
as it
ensures that the risks involved in borrowing or investment tools are reduced. That is because the risk involved may be detrimental to the MNC’s overall profitability and to the entire firm’s objective of maximizing share holders
wealth and profit.

When obtaining capital, the tax structure prevailing in the donor country is important to the MNC. The tax structure of a country determines the interest rates of loans and other sources of capital. The MNC’s finance department should therefore know the cost by making the rightful calculations
. For instance
when using the weighted average cost to determine the cost of capital, all the
cost of capital should be multiplied with
the proportion of capital structure, then divided with the total of proportion of capital structure per cent
and that should be done by considering the risks of loss from foreign exchange. A poor tax structure imposes heavy tax burdens to both the investors and the consumers. The MNC should therefore ensure that it does not incur unnecessary cost
by getting
capital from a country with a poor tax structure.

The MNC should consider the political environment and the consequent risk relating to various countries. Getting capital from a country with an unstable political environment is both risky and expensive (Siddaiah, 2009). The value of the currency of a politically unstable country is unpredictably
. The risk of losing money from the unstable currency is therefore high when a firm obtains capital from an unstable political environment.

With such considerations in mind, the MNC is likely to have balance sheets that indicate a truly healthy financial position. Using the above methods of determining the cost of capital;
cost of equity
and cost of debt, the considerations bring out the big and real picture of the MNC. The assets will be more than the liabilities and much more economically viable decision
of a big firm like the steel company; to expand operations, will be made
.

References

Siddaiah, T. (2009). International Financial Management. Upper Saddle River, NJ: Pearson.

Sinha, P. K., & Sinha, S. (2008). International Business Management: A Global Perspective. New Delhi: Excel Books.

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