Part 1
1) Cost of Capital Explain how characteristics of NCs can affect the cost of capital.
2) Target Capital Structure LaSalle Corp. is a U.S.-based MNC with subsidiaries in various less developed countries where stock markets are not well established. How can LaSalle still achieve its "global" target capital structure of 50 percent debt and 50 percent equity if it plans to use only debt financing for the subsidiaries in these countries?
3) Cost of Capital Blues, Inc., is an MNC located in the United States. Blues would like to estimate its cost of capital (WACC). On average, bonds issued by Blues yield 9 percent. Currently, Treasury security rates are 3 percent. Furthermore, Blues' stock has a beta of 1.5, and the return on the Wilshire 5000 stock index is expected to be 10 percent. Blues' target capital structure is 30 percent debt and 70 percent equity. If Blues is in the 35 percent tax bracket, what is its cost of capital?
4) Financing in a High-Interest Rate Country Fairfield Corp., a U.S. firm, recently established a subsidiary in a less developed country that consistently experiences an annual inflation rate of 80 percent or more. The country does not have an established stock market, but loans by local banks are available with a 90 percent interest rate. Fairfield has decided to use a strategy in which the subsidiary is financed entirely with funds from the parent. It believes that in this way it can avoid the excessive interest rate in the host country. What is a key disadvantage of using this strategy that may cause Fairfield to be no better off than if it paid the 90 percent interest rate?
Part 2
1) Bond Offering Decision Columbia Corp. is a U.S. company with no foreign currency cash flows. It plans to issue either a bond denominated in Euros with a fixed interest rate or a bond denominated in U.S. dollars with a floating interest rate. It estimates its periodic dollar cash flows for each bond. Which bond do you think would have greater uncertainty surrounding these future dollar cash flows? Explain.
2) Cost of Financing Assume that Seminole, Inc., considers issuing a Singapore dollar-denominated bond at its present coupon rate of 7 percent, even though it has no incoming cash flows to cover the bond payments. It is attracted to the low financing rate because U.S. dollar-denominated bonds issued in the United States would have a coupon rate of 12 percent. Assume that either type of bond would have a 4-year maturity and could be issued at par value. Seminole needs to borrow $10 million. Therefore, it will issue either U.S. dollar- denominated bonds with a par value of $10 million or bonds denominated in Singapore dollars with a par value of S$20 million. The spot rate of the Singapore dollar is $.50. Seminole has forecasted the Singapore dollar's value at the end of each of the next 4 years, when coupon payments are to be paid. Determine the expected annual cost of financing with Singapore dollars. Should Seminole, Inc., issue bonds denominated in U.S. dollars or Singapore dollars? Explain.
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End of the Year
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Exchange Rate of Singapore Dollar
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1
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$0.52
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2
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0.56
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3
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0.58
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4
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0.53
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3) Financing and Exchange Rate Risk Vix Co. (a U.S firm) presently serves as a distributor of products by purchasing them from other U.S. firms and selling them in Europe. It wants to purchase a manufacturer in Thailand that could produce similar products at a low cost (due to low labor costs in Thailand) and export the products to Europe. The operating expenses would be denominated in Thai currency (the baht). The products would be invoiced in Euros. If Vix Co. can acquire a manufacturer, it will discontinue its existing distributor business. If Vix Co. purchases a company in Thailand, it expects that its revenue might not be sufficient to cover its operating expenses during the first 8 years. It will need to borrow funds for an 8-year term to ensure that it has enough funds to pay all of its operating expenses in Thailand. It can borrow funds denominated in U.S. dollars, in Thai baht, or in Euros. Assuming that its financing decision will be primarily intended to minimize its exposure to exchange rate risk, which currency should it borrow? Briefly explain.
4) Project Financing Dryden Co. is a U.S. firm that plans a foreign project in which it needs $8,000,000 as an initial investment. The project is expected to generate cash flows of 10 million euros in 1 year after the complete repayment of the loan (including the loan interest and principal). The project has zero salvage value and is terminated at the end of 1 year. Dryden considers financing this project with:
• All US Equity
• All U.S. debt (loans) denominated in dollars provided by U.S. banks,
• All debt (loans) denominated in Euros provided by European banks, or
• Half of funds obtained from loans denominated in Euros and half obtained from loans denominated in dollars.
Which form of financing will cause the project's NPV to be the least sensitive to exchange rate risk?