Specific & Weighted Average Cost of Capital for MNCs

Just like domestic firms, MNCs calculate WACC. But the "Risk Free Rate" and "Beta" change.

1. Components

A. Cost of Equity (Ke)

• Calculated using International CAPM.
• Ke = Rf + Beta * (Rm - Rf).
• Difference: Rf is the Global Risk Free Rate. Beta is the sensitivity to the Global Market Index (not just BSE Sensex).

B. Cost of Debt (Kd)

• Kd = Interest Rate * (1 - Tax Rate).
• Advantage: MNCs can borrow in a currency with low rates (e.g., Euro).
• Risk: If that currency appreciates, the effective Kd shoots up.

2. WACC Formula

Ko = [ Ke * (E/V) ] + [ Kd * (D/V) ]

• Ke: Cost of Equity.
• Kd: Cost of Debt (Post-tax).
• E/V: Proportion of Equity.
• D/V: Proportion of Debt.

3. Diagram: The Flow

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4. Exam Notes: Writing the Answer

Question: "Explain how Cost of Equity is determined for an MNC." (5 Marks)

Answering Strategy:

1. Model: Mention CAPM (Capital Asset Pricing Model).
2. Formula: Write Ke = Rf + B(Rm-Rf).
3. Global Context: Explain that for an MNC, the 'Beta' measures risk relative to the World Portfolio, not domestic market.

Summary

• Target WACC: Every MNC aims to minimize WACC to maximize value.
• Tax Shield: Debt is cheaper because Interest is tax-deductible. MNCs exploit this across high-tax countries.

Quiz Time! 🎯

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