Financing and Exchange Rate Risk
Response to the following problem:
The parent of Nester Co. (a U.S. firm) has no international business but plans to invest $20 million in a business in Switzerland. Because the operating costs of this business are very low, Nester Co. expects this business to generate large cash flows in Swiss francs that will be remitted to the parent each year. Nester will finance half of this project with debt.
It has these choices for financing the project:
¦ obtain half of the funds needed from parent equity and the other half by borrowing dollars,
¦ obtain half of the funds needed from parent equity and the other half by borrowing Swiss francs, or
¦ obtain half of the funds that are needed from parent equity and obtain the remainder by borrowing an equal amount of dollars and Swiss francs. The interest rate on dollars is the same as the interest rate on Swiss francs
a. Which choice will result in the most exchange rate exposure?
b. Which choice will result in the least exchange rate exposure?
c. If the Swiss franc were expected to appreciate over time, which financing choice would result in the highest expected net present value?