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 struc- ture is 30 percent debt and 70 percent equity. If Blues is in the 35 percent tax bracket, what is its cost of capital?
Financing in a High–Interest Rate Country Fairfield Corp., a U.S. firm, recently established a sub- sidiary 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?
Financing Decision Cuanto Corp. is a U.S. drug company that has attempted to capitalize on new opportunities to expand in Eastern Europe. The pro- duction costs in most Eastern European countries are very low, often less than one-fourth of the cost in Germany or Switzerland. Furthermore, there is a strong demand for drugs in Eastern Europe. Cuanto pene- trated Eastern Europe by purchasing a 60 percent stake in Galena, a Czech firm that produces drugs.
a. ShouldCuantofinanceitsinvestmentintheCzechfirm by borrowing dollars from a U.S. bank that would then be converted into koruna (the Czech currency) or by bor- rowing koruna from a local Czech bank? What informa- tion do you need to know to answer this question?
b. How can borrowing koruna locally from a Czech bank reduce the exposure of Cuanto to exchange rate risk?
c. How can borrowing koruna locally from a Czech bank reduce the exposure of Cuanto to political risk caused by government regulations?
Bond Financing Analysis Hawaii Co. just agreed to a long-term deal in which it will export products to Japan. It needs funds to finance the production of the products that it will export. The products will be denominated in dollars. The prevailing U.S. long-term interest rate is 9 percent versus 3 percent in Japan. Assume that interest rate parity exists and that Hawaii Co. believes that the international Fisher effect holds.
a. Should Hawaii Co. finance its production with yen and leave itself open to exchange rate risk? Explain.
b. Should Hawaii Co. finance its production with yen and simultaneously engage in forward contracts to hedge its exposure to exchange rate risk?
c. How could Hawaii Co. achieve low-cost financing while eliminating its exposure to exchange rate risk?
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