Project Financing Strategy
Solve the following problem:
Konk Co., a U.S. firm, considers a project in which it would build a subsidiary in Belgium that would generate net cash flows of about 10 million euros per year for 5 years and would remit that amount to the parent each year. It has no other international business. It needs about 20 million euros as the initial outlay to establish the subsidiary.
It can finance this initial outlay in the following ways and the subsidiary would repay the amount of the investment evenly over the next 5 years:
(a) the parent can borrow dollars from a U.S. bank and convert them to euros,
(b) the parent can borrow euros from a Belgian bank,
(c) the parent can use its equity (retained earnings from existing business in the U.S.) and convert the funds into euros,
(d) the parent can borrow dollars from a Belgian bank and convert them to euros, and
(e) the parent can diversify its financing by obtaining one fourth of the funds from each of the preceding sources.
Assume that there is no cost advantage to any financing method. If Konk Co. wants to use a financing method to minimize its project's exposure to exchange rate risk, which method should it use? Briefly explain.