Question Details

Cost of Foreign Debt Versus Equity



1.	Financing Tradeoffs. Pullman, Inc., a U.S. firm, has been highly profitable, but prefers not to pay out higher dividends because its shareholders want the funds to be reinvested. It plans for large growth in several less developed countries. Pullman would like to finance the growth with local debt in the host countries of concern to reduce its exposure to country risk. Explain the dilemma faced by Pullman, and offer possible solutions.
2.	Costs of Capital Across Countries. Explain why the cost of capital for a U.S.-based MNC with a large subsidiary in Brazil is higher than for a U.S.-based MNC in the same industry with a large subsidiary in Japan. Assume that the subsidiary operations for each MNC are financed with local debt in the host country.
3. Cost of Foreign Debt Versus Equity. Carazona Inc. is a U.S. firm that has a large subsidiary in Indonesia. It wants to finance the subsidiary- operations in Indonesia. However, the cost of debt is presently about 30 percent there for firms like Carazona or government agencies that have a very strong credit rating. A consultant suggests to Carazona that it should use equity financing there to avoid the high interest expense. He suggests that since Carazona- cost of equity in the U.S. is about 14 percent, so the Indonesian investors should be satisfied with a return of about 14 percent as well. Clearly explain why the consultant- advice is not logical. That is, explain why Carazona- cost of equity in Indonesia would not be less than Carazona- cost of debt in Indonesia. 




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