Pormindplc, a well known manufacturing company in UK, has suffered nearly three years of losses due to the global financial crisis in 2008. In order to recovery from the consecutive losses situation, the new finance director suggested that Pormind should undertake some takeovers in different target countries to expand their operations. However, a huge amount of capital is needed to achieve these series acquisition activities. Although the finance director’s view is that the company can raise capital from target countries rather than in the UK, I personally think the drawbacks of taking this action are overweight the merits and my reasons are as follows.
In terms of the costs, we know that the most efficient and popular means of raising capital is making loans from banks or issuing bonds and equities through the exchanges. Therefore, the total cost involves interest rate, dividends and some other fees, such as listing fees and taxes. Although the economy of emerging markets developed rapidly in recent years, the capital markets are still too young comparing with the developed countries, like UK and USA. Thus, the sources of capital are limited and the cost of raising capital is relatively high in those emerging markets. Furthermore, the banks in UK know the company’s financial condition very well, it is easy and convenient to make loans for Pormind and the interest rate may be lower than expectations because of the competition.
On the other hand, the risk of raising capital from overseas should also be considered. The first important risk is the political risk which will decide whether the company can receive the capital safely and continuously. If there is a war happen in the target countries or the relationship between UK and those countries goes worse, the company will face problems about financing. In addition, the exchange rate risk is significant as well. If the currencies in foreign countries appreciate which means that the company should pay more dividend or interest than before, this may lead loss to some extent. Finally, the change of tax rate will increase the cost and this may be neglected by the company at the beginning.
However, there also have some advantages of raising capital locally rather than in the UK. As a strategic investor, the purpose of the company is taking acquisitions in foreign countries. Thus, if the company raises capital locally at first, the capital will become growth capital which is good for the company to establish the value of business.
In conclusion, whether it is right to raise capital from overseas rather than in UK should be determined by the conditions of the target countries. What the company should do is to consider the risks and comparing the cost carefully before taking actions.
References
David O. 1985. Real exchange rate risk, expectations, and the level of direct investment. The Review of Economics and Statistics.67, 297-308.
Brian J, Narasimhan J, Michael S. 2006. World markets for raising new capital. Journal of Financial Economics. 82, 63-101.
Mervyn A. 1974. Taxation and the cost of capital. The Review of Economics and Statistics. 41, 21-35.
Nevins D. 1967. Leverage, risk of return and the cost of capital. The Journal of Finance. 22, 395-403.
Part B
Introduction
It is common sense that all kinds of business transactions involve different degree of risk. When those transactions occur across the borders of countries, they will carry additional risk than domestic business. Typically, we call it country risk which represents the potential influence of a country’s environment on a multinational company’s cash flows. Therefore, country risk analysis attempts to identify the factors which will increase the risk of a decline in expected return for a foreign direct investment. Generally speaking, there are three types of country risk, including political risk, economic risk and financial risk.
