Cost of Capital for Multinational Corporations Vs Domestic Firms

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The cost of capital for an MNC may differ from that of a fully established domestic firm on account of the characteristics of MNCs that differentiate them from domestic firms. These differences include the following. 1. Size of firm: Firms that operate internationally are usually much bigger in size than firms which operate only in the domestic market. Firms that operate internationally generally borrow substantial amounts of funds and by virtue of their size, they are generally in a position to reduce the various transaction and brokerage costs and also get preferential treatment from creditors. This helps them to reduce their cost of capital compared to domestic firms. 2. Foreign Exchange risk: An exceptionally volatile exchange rate, or one that always depreciates, is not conductive to attracting long-term foreign investors. Such a MNCs cash flow would have wide fluctuations and the capability of the corporation to make various fixed term commitments like interest would get reduced. This may force the shareholders and creditors to demand a higher return which, in turn, increases the MNC’s cost of capital. A firm more exposed to exchange rate fluctuations would have a wider spread of possible cash flows in future periods. thus, exposure to exchange rate fluctuations could lead to a higher cost of capital.

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