Financing with Foreign Equity
Response to the following problem:
Orlando Co. has its U.S. business funded in dollars with a capital structure of 60 percent debt and 40 percent equity. It has its Thailand business funded in Thai baht with a capital structure of 50 percent debt and 50 percent equity. The corporate tax rate on U.S. earnings and on Thailand earnings is 30 percent. The annualized 10- year risk-free interest rate is 6 percent in the United States and 21 percent in Thailand. The annual real rate of interest is about 2 percent in the United States and 2 percent in Thailand. Interest rate parity exists. Orlando pays 3 percentage points above the risk-free rates when it borrows, so its before-tax cost of debt is 9 percent in the United States and 24 percent in Thailand. Orlando expects that the U.S. stock market return will be 10 percent per year, and expects that the Thailand stock market return will be 28 percent per year. Its business in the United States has a beta of .8 relative to the U.S. market, while its business in Thailand has a beta of 1.1 relative to the Thai market. The equity used to support Orlando's Thai business was created from retained earnings by the Thailand subsidiary in previous years. However, Orlando Co. is considering a stock offering in Thailand that is denominated in Thai baht and targeted at Thai investors. Estimate Orlando's cost of equity in Thailand that would result from issuing stock in Thailand.