Question 18.PP.8: The liabilities in the balance sheet of a USA based company ......
The liabilities in the balance sheet of a USA based company are:
The cost of equity capital is 15 per cent and the cost of debt is 6 per cent in the USA. The USA based company is planning to start a subsidiary in India. The Indian subsidiary will be making an investment of Rs 100 million. The interest rate in India is 10 per cent and the Indian rupee is expected to depreciate at the rate of 3 per cent per year. Tax rate in India is 35 per cent. The US company wants to maintain the capital structure of the Indian subsidiary in line with the parent’s capital structure. What will the cost of capital be if the subsidiary is financed by the parent company and through Indian loans?
| US dollar 400 million | Owner’s capital |
| 600
|
Debts |
| 1,000 | Total |
Debt and equity are in the proportion of 3:2 in the capital structure of the parent company. This implies that the Indian subsidiary will have Rs 40 million of equity and Rs 60 million of debt.
\, The cost of the equity capital is that of the parent, i.e., 15 per cent; the cost of debt would be 0.10 (1 – 0.35) (1 – 0.03) – 0.03 = 0.033 or 3.3 per cent.
\, So, the weighted average cost of capital would be: (15 × 40/100 + 3.3 × 60/100) = 7.98 per cent.