Financial Structure and International Debt Essay

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Chapter 14
Financial Structure and International Debt
( Questions

1. Objective. What, in simple wording, is the objective sought by finding an optimal capital structure? When taxes and bankruptcy costs are considered, a firm has an optimal financial structure determined by that particular mix of debt and equity that minimizes the firm’s cost of capital for a given level of business risk. If the business risk of new projects differs from the risk of existing projects, the optimal mix of debt and equity would change to recognize trade-offs between business and financial risks.

2. Varying Debt Proportions. As debt in a firm’s capital structure is increased from no debt to a significant proportion of debt (say, 60%),
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Returns are not perfectly correlated between countries.

In contrast, a domestic German firm would not enjoy the benefit of cash flow international diversification but would have to rely entirely on its own net cash inflow from domestic operations. Perceived financial risk for the German firm would be greater than for a multinational firm because the variability of its German domestic cash flows could not be offset by positive cash flows elsewhere in the world.

5. Ex-Post Cost of Borrowing. Exhibit 14.2 in the text shows that Deutsche Bank borrowed funds at a nominal cost of 9.59% per annum, but at a later date that debt was selling to yield 7.24%. Near the other extreme, the Kingdom of Thailand borrowed funds at a nominal cost of 8.70% but after the fact found the debt was sold in the market at a yield of 11.87%. What caused the changes, in this case in opposite directions, and what might management do to benefit (as Deutsche Bank did) rather than suffer (as the Kingdom of Thailand did)?

Changes in foreign exchange rates caused the ex-post cost of borrowing to increase or decrease from what was originally expected. Management can only guess at future foreign exchange risk. Therefore, they could either borrow only in their functional currency or diversify by currency their sources of borrowing.

6. Local Norms.
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