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’s operations in Indonesia, but the cost of debt is currently 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 in Indonesia to avoid the high interest expense. He suggests that because Carazona’s cost of equity in the United States is about 14 percent, the Indonesian investors should be satisfied with a return of about 14 percent as well. Clearly explain why the consultant’s advice is not logical. That is, explain why Carazona’s cost of equity in Indonesia would not be less than Carazona’s cost of debt in Indonesia.

FindFind

International Financial Management

14th Edition
Madura
Publisher: Cengage
ISBN: 9780357130698
FindFind

International Financial Management

14th Edition
Madura
Publisher: Cengage
ISBN: 9780357130698

Solutions

Chapter 17, Problem 21QA
Textbook Problem

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’s operations in Indonesia, but the cost of debt is currently 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 in Indonesia to avoid the high interest expense. He suggests that because Carazona’s cost of equity in the United States is about 14 percent, the Indonesian investors should be satisfied with a return of about 14 percent as well. Clearly explain why the consultant’s advice is not logical. That is, explain why Carazona’s cost of equity in Indonesia would not be less than Carazona’s cost of debt in Indonesia.

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