Tutorial Answers for WEEK 13

CHAPTER 14

RAISING EQUITY AND DEBT GLOBALLY

13. Cross-Listing. What are the main benefits and disadvantages to firms that cross-list their
shares on multiple stock markets?

Cross listing is when a firm lists its shares on one or more foreign stock exchanges in addition
to its primary listing on the domestic stock exchange. The main advantages of secondary
listing (issuing on stock exchanges other than the primary listing) are to access new markets
with increased amounts of capital and to benefit from the possible lower cost of capital on
these markets. A second important advantage of cross-listings on deeper and more mature
equity markets is to gain more liquidity of the stock. This is especially important for some
emerging markets that may suffer from shallowness and/or low levels of trading and
liquidity. Sometimes firms may resort to cross-listing when they are planning on future
foreign acquisitions or when they need to improve their disclosure and corporate
governance procedures that are required by deep and mature stock markets. In addition to
the higher listing fees, cross-listing has a number of disadvantages. The main drawbacks are
placing more pressure on the management and executive teams of the firm to meet the
increased reporting and disclosure requirements. Further, since the firm will have to be
placed under public scrutiny, the management may reveal some of its plans and policies that
may have led to its increased competitiveness.

15. Main advantages of localization. The main advantages of a finance structure for foreign
subsidiaries that conforms to local debt norms are as follows:

 A localized financial structure reduces criticism of foreign subsidiaries that have been
operating with too high a proportion of debt (judged by local standards), often resulting
in the accusation that they are not contributing a fair share of risk capital to the host
country. At the other end of the spectrum, a localized financial structure would improve
the image of foreign subsidiaries that have been operating with too little debt and thus
appear to be insensitive to local monetary policy.

 A localized financial structure helps management evaluate return on equity investment

relative to local competitors in the same industry. In economies where interest rates are
relatively high as an offset to inflation, the penalty paid reminds management of the need
to consider price level changes when evaluating investment performance.

 In economies where interest rates are relatively high because of a scarcity of capital, and
real resources are fully utilized (full employment), the penalty paid for borrowing local
funds reminds management that unless return on assets is greater than the local price of
capital—that is, negative leverage—they are probably misallocating scarce domestic real
resources such as land and labor. This factor may not appear relevant to management

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 Tutorial Answers for WEEK 13

decisions, but it will certainly be considered by the host country in making decisions with
respect to the firm.

Main disadvantages of localization. The main disadvantages of localized financial structures

are as follows:

 An MNE is expected to have a comparative advantage over local firms in overcoming

imperfections in national capital markets through better availability of capital and the
ability to diversify risk. Why should it throw away these important competitive
advantages to conform to local norms established in response to imperfect local capital
markets, historical precedent, and institutional constraints that do not apply to the MNE?

 If each foreign subsidiary of an MNE localizes its financial structure, the resulting
consolidated balance sheet might show a financial structure that does not conform to any
particular country’s norm. The debt ratio would be a simple weighted average of the
corresponding ratio of each country in which the firm operates. This feature could
increase perceived financial risk and thus the cost of capital for the parent, but only if two
additional conditions are present:

1. The consolidated debt ratio is pushed completely out of the discretionary range of
acceptable debt ratios in the flat area of the cost of capital curve, shown previously in
Exhibit 16.1.

2. The MNE is unable to offset high debt in one foreign subsidiary with low debt in other
foreign or domestic subsidiaries at the same cost. If the International Fisher effect is
working, replacement of debt should be possible at an equal after-tax cost after
adjusting for foreign exchange risk. On the other hand, if market imperfections
preclude this type of replacement, the possibility exists that the overall cost of debt,
and thus the cost of capital, could increase if the MNE attempts to conform to local
norms.

 The debt ratio of a foreign subsidiary only cosmetic because lenders ultimately look to
the parent and its consolidated worldwide cash flow as the source of repayment. In many
cases, debt of subsidiaries must be guaranteed by the parent firm. Even if no formal
guarantee exists, an implied guarantee usually exists because almost no parent firm
would dare to allow an affiliate to default on a loan. If it did, repercussions would surely
be felt with respect to the parent’s own financial standing, with a resulting increase in its
cost of capital.

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 Tutorial Answers for WEEK 13

Problem 14.7

"M.M. Monroe Manufacturing, Inc., a French multinational company, has the following debt
components on its balance sheet. M.M. Monroe’s finance staff estimates their cost of equity to
be 15%. Income taxes are 25% around the world after allowing for credits. Calculate
M.M.Monroe’s weighted average cost of capital based on the below mentioned capital structure
components.

Assumption Value (Given)

Pre-tax Cost (%)
Tax rate 25.00%
25-year euro bonds €10,000,000 6.000%
5-year euro notes €4,000,000 4.000%
Shareholders' equity €50,000,000 15.000%
10-year British pound bonds (GBP) £10,000,000 5.000%
20-year Swiss franc bonds (CHF) 25,000,000 2.000%
Spot rate (€/£) 1.4100
Spot rate (¥/CHF) 0.9600
Spot rate (CHF/€) 138.00

where, Post-tax rate = Pre-tax(1-t)

WACC = Proportion * Post-tax rate

(Need to (Given) (Need to (Need to

Euro calculate) Pre-tax Calculate) calculate)
Component Amount Proportion Cost (%) Weighted
Post-tax Component
Cost (%) Cost (%)

25-year euro bonds €10,000,000 12.77% 6.000% 4.500% 0.5749%

5-year euro notes 4,000,000 5.11% 4.000% 3.000% 0.1533%
10-year British pound bonds (in 14,100,000 18.01% 5.000% 3.750% 0.6754%
Euro)
20-year Swiss franc bonds (in 181,159 0.23% 2.000% 1.500% 0.0035%
Euro)
Shareholders' equity 50,000,000 63.87% 15.000% 15.000% 9.5808%
Total €78,281,159 100.00% WACC = 10.9879%

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 Tutorial Answers for WEEK 13

Problem 14.16

ChocTurk Co. is a Turkish chocolate manufacturer that exports its products to neighboring
European nations. Since its clients are mostly European, ChocTurk Co. evaluates all business
results and financial transactions in euros. It needs to borrow €5,000,000 or the foreign currency
equivalent for four years. It decides to issue bonds, making one annual payment at the end of
each year. The following are the alternatives:

a. Sell Japanese yen bonds at par yielding 2% per annum. The current exchange rate is ¥136/€,
and the yen is expected to strengthen against the euro by 3% per annum.

b. Sell Sterling-denominated bonds at par yielding 5% per annum. The current exchange rate is
€0.7350/£, and the pound is expected to weaken against the euro by 4% per annum.

c. Sell euro bonds at par yielding 4% per annum.

Which course of action do you recommend Choco Turk Co. take and why?

You are requested to manually calculate the IRR for this problem usually a range of +/- 1% will
be an acceptable answer.

Japanese Sterling Euro

Alternatives yen bonds pound bonds
bonds
Coupon rate 2.000% 5.000% 4.000%
Current cross rate 136.00 0.7350
Expected change in the value of the foreign 3.000% -4.000% 0.000%
currency
Principal needed by ChocoTurk Co. €5,000,000
Refer to Formulae Table for Appreciation and Depreciation Formulae

Reference to the exchange rate for Sterling pound-denominated bonds €0.7350/£, and the
pound is expected to weaken against the euro by 4% per annum.

0.735 0.7067 0.7362 0.7669 0.7988 (EURO/POUND)

1.361 1.415 1.471 1.530 1.592 (POUND/EURO)

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 Tutorial Answers for WEEK 13

Calculation of the dollar cost debt

alternatives Year 0 Year 1 Year 2 Year 3 Year 4

Japanese yen bonds:

Proceeds and principal and interest
payments ¥680,000,000 -¥13,600,000 -¥13,600,000 -¥13,600,000 -¥693,600,000

Expected exchange rate (yen/euro) 136.00 132.04 128.19 124.46 120.83

Euro equivalent in expected cash flows €5,000,000 -€102,999 -€106,093 -€109,272 -€5,740,296
IRR of euro cash flow stream (cost of
funds) 5.061%

Sterling pound-denominated bonds:

Proceeds and principal and interest
payments £6,802,721 -£340,136.05 -£340,136 -£340,136 -£7,142,857

Expected exchange rate (euro/pound) 0.735 0.7067 0.6795 0.6534 0.6283

Euro equivalent in expected cash flows €5,000,000 -€240,385 -€231,122 -€222,245 -€4,487,857
IRR of euro cash flow stream (cost of
funds) 0.962%

Euro bonds:
Proceeds and principal and interest
payments in Euro €5,000,000 -€200,000 -€200,000 -€200,000 -€5,200,000
IRR of euro cash flow stream (cost of
funds) 4.000%

FIN3034 – INTERNATIONAL FINANCIAL MANAGEMENT