In this assignment you are asked to estimate the adjustments a MNE would make to

In
this assignment you are asked to estimate the adjustments a MNE would make to
its cost of capital for an acquisition in the countries and currencies you have
chosen to work on. There are several approaches to estimating the cost of
capital in overseas markets. In the appendix entitled “Supplement on
Emerging Market Discount Rates” four are summarized. For this assignment
we will rely upon a simpler approach that emphasizes the spread (or difference)
between the cost of sovereign debt in the U.S. and the cost of sovereign debt
in your chosen countries.
First,
as eview and using our textbook’s notation, recall from Chapter13, the
traditional equation for the weighted average cost of capital (kWACC):
kWACC = kE+kV (1-t)DdV
Where:
ke=
cost of equity
kd=before-tax
cost of debt t = marginal tax rate
E=market
value of the firm’s equity D = market value of the firm’s debt
V=
market value of the firm’s securities (E + D)
Commonly
the cost of equity (ke) is determined using the Capital Asset Pricing
Model(CAPM) defined as:
Ke = Cost of Equity = krf+�m(km-krf) where:
Ke =
expected (required) rate of return on equity
kr
f= rate of interest on risk-free bonds (Treasury bonds, for example)
�m = coefficient of systematic risk for
the firm (beta)
km = expected (required) rate of return on the
market portfolio of stocks According to R. Hacker (using different notation):
The
problem in this formula is in determining Rm, expected return on the equity
market, and ke (equity beta). Many countries have small publicly
traded equity markets or stocks have very small daily or annual trading
volumes. Such a shortage of reliable data makes the determination of R may be
questionable.
[An
alternative to the traditional CAPM formula is proposed]:
Cost of Equity =Rd+(Rmu – Rfu) + (Rfx-Rfu) where:
Rd=
cost of debt of the acquired company
Rmu =Expected return on the equity market in the U.S.
Rfu= Expected risk free rate in the U.S.
(Rm-
Rfu is the premium for equity risk in the U.S.)
Rfx=
Expected risk free rate in the country of the
acquisition
(Rfx-Rfu
is the country risk premium (based on the difference in yield for sovereign bonds)
The advantage of this formula is that almost every company
anywhere in the world has a cost of debt and debt cost is almost always a free
market determination. To the cost of debt what the formula does is add the
premium for equity in the U.S. plus a country risk premium, which adjusts the
U.S. equity premium upward to consider country risk.
[I]f the foreign country has no sovereign debt. I would
reconsider the acquisition because the country is very undeveloped, and it
might be less capital at risk to build a company from scratch. If you still
want to do an acquisition, I would use the interest rate of the largest company
in the country that has issued public or private debt as a surrogate for
sovereign debt. The government should have a lower cost of debt than a private
company but this company’s cost of debt is an objective number and a bit conservative
(which is not a bad thing in a foreign acquisition).
Source:http://sophisticatedfinance.typepad.com/sophisticated_finance/2013/08/calculating-international-cost-of-capital.html
Following
this approach you are asked to determine the cost of equity for an acquisition
in both of your chosen countries and currencies using the following formula:
Ke = Cost  of Equity = kd + (kUSmkt-kUSrf)
+ (kForeignSovDebt-kUSrf )
where
kd= kForeignSovDebt+2%
kUSmkt=
Expected return on the S&P500
kUSrf
= Current yield on 10-yearU.S.Treasury’s
kForeignSovDebt =
Current yield on10-year sovereign debt in your chosen country