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CHAPTER 17 International Capital Structure and the Cost of Capital

Does cost of capital differ arround countries?

Solutions

The solution to reduced home bias and greater global risk sharing would help reduce the cost of capital.

Accounting transparency also helps reduce the cost of capital.

If the home market is imperfect then an international financing can lower the firm's cost of capital.

Cost of Capital

Yes,is likely to vary across countries due to international differences in the degree of financial integration, quality of corporate governance, macroeconomic conditions, and other factors.

The cost of capital is related to the home bias.

Home bias: reflects the country's degree of financial integration with the rest of the world.

Cross Listing Costs...

Cost of capital

The minimum rate of return an investment project must generate in order to pay its financing costs.

  • It is used to evaluate new projects of a company

So..

When a firm identifies and undertakes an investment project that generates a return exceeding its cost of capital, the firm's value will increase

Cross listing brings more benefits…

Cross-Border Listings of Stocks

1. the share price reacts favorably to cross-border listings

2. the total post listing trading volume increases on average, and, for many issues, home-market trading volume also increases

3. liquidity of trading in shares improves overall

4. stock's exposure to domestic market risk is significantly reduced

Many companies use a combination of debt and equity to finance their businesses

Listing of a company's common shares on a different exchange than its primary and original stock exchange.

When a firm has both debt and equity in its capital structure, its financing cost can be represented by the weighted average cost of capital.

Capital Asset Pricing under Cross Listing

Here we’ll discuss the International Asset Pricing Model (IAPM)…

Fist we use the formula of CAPM which is:

http://www.investopedia.com/video/play/what-is-wacc/

Advantages

Why is it important?

Some of the advantages to cross-listing include having shares trade in multiple time zones and in multiple currencies. This gives issuing companies more liquidity and a greater ability to raise capital.

A company looking to lower its WACC may decide to increase its use of cheaper financing sources.

For instance, Corporation x may issue more bonds instead of stock because it can get the financing more cheaply.

It's important for a company to know its weighted average cost of capital as a way to gauge the expense of funding future projects.

The lower a company's WACC, the cheaper it is for a company to fund new projects.

Many exchanges of the world are now competing for cross-listings and trading volume of international stock.

  • The company can expand its potential investor base.

  • Creates a secondary market for the company's shares, (raising new capital in foreign markets)

  • Enhance the liquidity of the company's stock.

  • Enhances the visibility of the company's name and its products in foreign marketplaces.

  • Shares may be used as the "acquisition currency" for taking over foreign companies.

  • It may improve the company's corporate governance and transparency.

In other words, internationally tradable assets will be priced as if world financial markets were completely integrated, regardless of the nationality, a tradable asset will be priced solely according to its world systematic risk as described in

Cost of Capital in Segmented versus Integrated Markets

The Effectt of Foreign Equity Ownership Restrictions

Asset Pricing under Foreign Ownership Restrictions

Pricing-to-Market Phenomenon

The IAPM has a few interesting implications.

First, international listing (trading) of assets in otherwise segmented markets directly integrates international capital markets by making these assets tradable.

Second, firms with nontradable assets essentially get a free ride from firms with tradable assets in the sense that the former indirectly benefit from international integration in terms of a lower cost of capital and higher asset prices, without incurring any associated costs.

International financial markets are certainly not segmented anymore, but still are not fully integrated.

If international financial markets are less than fully integrated, there can be systematic differences in the cost of capital among

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