Question: Princess Cruise Company (PCC) purchased a ship from Mitsubishi Heavy Industry for 500 million yen payable in one year. The current spot rate is ¥124/$ and the one-year forward rate is 110¥/$. The annual interest rate is in Japan is 5% for lending and 6% for borrowing; and in the United States it is 7% for lending and 8% for borrowing. The WACC is 7%. PCC can also buy a one-year call option on yen at the strike price of $0.0081 per yen for a premium of 0.00014$/¥.
1. Assuming that the forward exchange rate is the best predictor of the future spot rate, compute the expected future dollar cost of meeting this obligation when the option hedge is used.
2. At what future spot rate do you think PC may be indifferent between the option and the forward hedge?