BLADE INC.COST OF CAPITAL

Presented By Debashish -1224108211 K. Mehar Raghav -1224108218 Khusboo Bharati -1224108219 Lawi Anupam -1224108221 Manish Mishra -1224108223 Pulasta Datta Gupta -1224108227

GITAM INSTITUTE OF INTERNATIONAL BUSINESSVISAKHAPATNAM

Blades Inc. Case Wants to establish a subsidiary in Thailand.Ben Holt believes the growth potential in Thailand is very high.Forecasts indicate the Baht may continue to depreciate .NPV = $ 8mn.Discount Rate = 25%Costs of both debt and equity in Thailand is higher than that in USA

Blades’ capital structure.Company size, access to Thai capital markets,

diversification, exposure to exchange rate risk, exposure to country risk.

Thai Interest rate – 15%US interest rate – 8%Blades Beta is assumed to drop from 2.0 to 1.8 Rf = 5%, Rm = 12%.

PROBLEM 1• If Blades expands into Thailand, cost of capital will be

higher than the cost of capital of roller blade manufacturers operating in U.S.

REASONSCost of debt and cost of equity are higher in ThailandCost of equity is higher since opportunity cost is high

in Thailand.Cost of debt is higher since interest rate is higher than

U.S.

IR (Thailand) = 15%

IR (U.S) = 8%

CHARACTERISTICS THAT DIFFERENTIATE BLADES’ FROM DOMESTIC ROLLER BLADE

• Blade is relatively small as compared to U.S. roller blade manufacturers.

• Blade’s expansion into Thailand will give access to the capital and money markets.

• Blade would be subjected to the economic conditions of both Thailand and U.S.

• Blade’s probability of bankruptcy would be reduced

• Exposure to country risk

• Exposure to exchange rate risk

PROBLEM 2 - - Using CAPM Model

Rf = 5%

Rm= 12%

β1=2.0

Rj1= Rf + β1(Rm-Rf)

= 5% + 2.0 (12%-5%)

= 19%

Rf = 5%

Rm= 12%

β1=1.8

Rj2 = Rf + β2(Rm-Rf)

= 5% + 1.8 (12% -5%)

= 17.6%

The cost of equity decreased by 1.4% due to decrease in beta value and we consider only the systematic risk.

Effect in Cost of capital

• cost of debt is more in Thailand as compare to U.S.• Cost of equity is also high in Thailand as compare to

U.S.• But CAPM shows that rate of return become

decreased – Due to decrease in beta value .– We only consider the systematic risk.

Determination of NPV

• NPV calculated by WACC. (which is not known)

• NPV = ∑ cash flow ( cash flow is not known (1+k)^n for each year)

Where k is discount rate , n is time period .

• Discounted rate = 25%, and NPV= $8 million

NPV = cash flow 1 year + cash flow 2years +……….. + (1+.25)^1 (1+.25)^2 market value (1+.25)^10

PROBLEM 3

• If Blades borrows funds in Thailand to support its Thai subsidiary, its cost of capital would probably increase.

REASONSThe cost of debt in Thailand is greater than

that in the U.S.High interest rate.

Q) With high level of (Interest Rates + Exchange Rate Risk + Country Risk) in Thailand, will Blades be more or less likely to use debt in its capital structure as a result of expansion into Thailand ?1. 30% Thai Debt - 30% X 15%2. 70% Equity - 70% X 19% = 17.8%

• 50% Thai Debt - 50% X 15%• 50% Equity - 50% X 19% = 17%

a) 70% Thai Debt - 70% X 15%b) 30% Equity - 30% X 19% = 16.2%

o 50% Thai Debt - 50% X 15%o 20% U.S. Debt - 20% X 8%o 30% Equity - 30% X 19% = 14.8%

Same Q contd…

1) 35% Thai Debt - 35% X 15%2) 35% US Debt - 35% X 8%3) 30% Equity - 30% X 19% = 13.75%

20% Thai Debt - 20% X 15% 50% US Debt - 50% X 8% 30% Equity - 30% X 19% =

[ OR ]

12.75%

Same Q contd… 70% US Debt - 70% X 8% 30% Equity - 30% X 19% =

By using this leverage, Interest Rates can be reduced to the maximum extent.

The Exchange Rate Risk can be reduced by using Forward Rates and Currency Swaps in the subsequent years.

A likely way to reduce the Country Risk is Issue Stocks in the host country. Minority Shareholders benefit directly from a profitable subsidiary Pressurize their government to refrain from imposing excessive taxes,

environmental constraints or any other provisions. Having local investors owning a minority interest – may offer protection

against threats of adverse actions by host government. The subsidiary’s name will also be familiar.

11.3%

THANK YOU