MNC’s Cost of Capital – Factors & Need for Adjustment

Cost of Capital (Ko) is the minimum return expected by investors. Does an MNC have a higher or lower Ko than a domestic firm?

1. The Debate: Higher or Lower?

Argument for LOWER Cost of Capital (Advantage MNC)

1. Size: MNCs are huge. They get "Prime Rate" loans.
2. Access to Global Capital: If rates are high in India (10%), they borrow in Japan (1%).
3. Diversification: MNCs don't rely on one country's economy. This lowers their "Beta" (Sys Risk).

Argument for HIGHER Cost of Capital (Disadvantage MNC)

1. Forex Risk: Earnings are volatile due to currency.
2. Political Risk: Assets might be seized.
3. Agency Costs: Hard to monitor a manager sitting in Brazil from a Head Office in Mumbai.

Verdict: Generally, MNCs enjoy a Lower Cost of Capital due to global access.

2. Factors Influencing MNC's Cost of Capital

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3. Exam Notes: Writing the Answer

Question: "Discuss the factors affecting Cost of Capital of an MNC." (10 Marks)

Answering Strategy:

1. Define: Ko is the hurdle rate.
2. Compare: Domestic vs MNC.
3. Listing: Use the 4 points above (Size, Access, Diversification, Risk).
4. Conclusion: "Despite higher political risk, the ability to tap global markets usually lowers the Ko for MNCs."

Summary

• Global Access: The biggest advantage. An Indian firm creates an MNC structure just to access cheap US debt.
• Risk Premium: Investors demand a premium for political risk, but this is often outweighed by the cheap debt benefit.

Quiz Time! 🎯

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