Assume that an MNC subsidiary has very volatile cash flows and uses high debt. Its cost of debt should be: a. lower than the country's risk-free rate. b. higher than the parent's cost of debt. c. higher than its cost of equity. d. lower than its credit risk premium.

Since equity investors take on more risk when buying a company's stock rather than its bond, the cost of equity is typically higher than the cost of debt. Due to the higher level of risk involved in investing in stocks, an equity investor would therefore demand higher returns (known as a "Equity Risk Premium") than a comparable bond investor. Investing in stocks carries greater risk than investing in bonds for a variety of reasons, such as:

Returns on the stock market are more volatile than on the bond market.
In the event of a company default, stockholders have a lesser claim to the company's assets.
Gains from investments are not assured.
Dividends are a choice (i.e., a company has no legal obligation to issue dividends)

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