1.The dollar cost of debt for Coval Consulting, a U.S. research firm, is 7.5%. The firm faces a tax rate of 30% on all income, no matter where it is earned. Managers in the firm need to know its yen cost of debt because they are considering launching a new bond issue in Tokyo to raise money for a new investment there. The risk-free interest rates on dollars and yen are r$ = 5% and r¥ = 1%, respectively. Coval Consulting is willing to assume that capital markets are internationally integrated and that its free cash flows are uncorrelated with the yen-dollar spot rate. What is Coval Consulting’s after-tax cost of debt in yen? (Hint : Start by finding the aftertax cost of debt in dollars and then find the yen equivalent.)
2.Manzetti Foods, a U.S. food processing and distribution company, is considering an investment in the euro area. You are in Manzetti’s corporate finance department and are responsible for deciding whether to undertake the project. The expected free cash flows, in euros, are uncorrelated to the spot exchange rate and are shown here:
The new project has similar dollar risk to Manzetti’s other projects. The company knows that its overall dollar WACC is 9.5%, so it feels comfortable using this WACC for the project. The riskfree interest rate on dollars is 4.5% and the risk-free interest rate on euros is 7%.
a. Manzetti is willing to assume that capital markets in the United States and the euro area are internationally integrated. What is the company’s euro WACC?
b. What is the present value of the project in euros?
3.Tailor Johnson, a U.S. maker of fine menswear, has a subsidiary in Ethiopia. This year, the subsidiary reported and repatriated earnings before interest and taxes (EBIT) of 100 million Ethiopian birrs. The current exchange rate is 8 birr/$ or S1 = $0.125/birr. The Ethiopian tax rate on this activity is 25%. U.S. tax law requires Tailor Johnson to pay taxes on the Ethiopian earnings at the same rate as profits earned in the United States, which is currently 45%. However, the United States gives a full tax credit for foreign taxes paid up to the amount of the U.S. tax liability. What is Tailor Johnson’s U.S. tax liability on its Ethiopian subsidiary?
4.Tailor Johnson, the menswear company with a subsidiary in Ethiopia described in Problem 9, is considering the tax benefits resulting from deferring repatriation of the earnings from the subsidiary. Under U.S. tax law, the U.S. tax liability is not incurred until the profits are brought back home. Tailor Johnson reasonably expects to defer repatriation for 10 years, at which point the birr earnings will be converted into dollars at the prevailing spot rate, S10, and the tax credit for Ethiopian taxes paid will still be converted at the exchange rate S1 = $0.125/birr. Tailor Johnson’s after-tax cost of debt is 5%.
a. Suppose the exchange rate in 10 years is identical to this year’s exchange rate, so S10 = $0.125/birr. What is the present value of deferring the U.S. tax liability on Tailor Johnson’s Ethiopian earnings for 10 years?
b. How will the exchange rate in 10 years affect the actual amount of the U.S. tax liability? Write an equation for the U.S. tax liability as a function of the exchange rate S10.
5.Peripatetic Enterprises, a U.S. import-export trading firm, is considering its international tax situation. U.S. tax law requires U.S. corporations to pay taxes on their foreign earnings at the same rate as profits earned in the United States; this rate is currently 45%. However, a full tax credit is given for the foreign taxes paid up to the amount of the U.S. tax liability. Peripatetic has major operations in Poland, where the tax rate is 20%, and in Sweden, where the tax rate is 60%. The profits, which are fully and immediately repatriated, and foreign taxes paid for the current year are shown here:
a. What is the U.S. tax liability on the earnings from the Polish subsidiary assuming the Swedish subsidiary did not exist?
b. What is the U.S. tax liability on the earnings from the Swedish subsidiary assuming the Polish subsidiary did not exist?
c. Under U.S. tax law, Peripatetic is able to pool the earnings from its operations in Poland and Sweden when computing its U.S. tax liability on foreign earnings. Total EBIT is thus $180 million and the total host country taxes paid is $76 million. What is the total U.S. tax liability on foreign earnings? Show how this relates to the answers in parts (a) and (b).
6.Suppose the interest on Russian government bonds is 7.5%, and the current exchange rate is 28 rubles per dollar. If the forward exchange rate is 28.5 rubles per dollar, and the current U.S. risk-free interest rate is 4.5%, what is the implied credit spread for Russian government bonds?
7.Assume that in the original Ityesi example in Table 31.1, all sales actually occur in the United States and are projected to be $60 million per year for four years. Keeping other costs the same,calculate the NPV of the investment opportunity.