Financing Decision
Response to the following problem:
The subsidiaries of Forest Co. produce goods in the United States, Germany, and Australia and sell those goods in the areas where they are produced. Foreign earnings are periodically remitted to the U.S. parent. As the euro's interest rates have declined to a very low level, Forest has decided to finance its German operations with borrowed funds in place of the parent's equity investment. Forest will transfer its equity investment in the German subsidiary over to its Australian subsidiary. These funds will be used to pay off a floating rate loan, as Australian interest rates have been high and are rising. Explain the expected effects of these actions on the consolidated capital structure and cost of capital of Forest Co. Given the strategy to be used by Forest, explain how its exposure to exchange rate risk may have changed.