Question

X Co., is a U.S.-based MNC that needs funding for a project in Russia:

U.S. risk-free rate = 6 %

Russia risk-free rate = 6 %

Risk premium on dollar-denominated debt provided by U.S. creditors = 4 %

Risk premium on euro-denominated debt provided by Russian creditors = 5 %

Beta of the venture = 1.2

Expected market return in the U.S. = 10%

U.S. corporate tax rate = 30%

Russian corporate tax rate = 40%

In what country should X finance its debt?

a.	U.S.
b.	Russia
c.	Either country since the cost of debt is the same
d.	Not enough information is provided to answer the question

Answer 1

Solution:

Dollar denominated cost of debt

=Risk premium on dollar-denominated debt provided by U.S. creditors+Risk premium on euro-denominated debt provided by Russian creditors

=4%+5%

=9%

After tax Dollar denominated cost of debt=9%*(1-Tax rate(U.S))

=9%(1-0.30)=6.3%

Euro-denominated cost of debt

=4%+5%=9%

After tax Euro-denominated cost of debt=9%(1-tax rate(Russia))

=9%(1-0.40)=5.4%

Since,the cost of debt is lesss in Russia,X should finance in Russia.The correct answer is Option B