Assignment # 3

1. The following transactions (expressed in U.S. $ billions) take place during a year. Calculate the U.S. merchandise-trade, current-account, financial-account, and official reserves balances. (5.4)

a. The United States exports $300 of goods and receives payment in the form of foreign demand deposits abroad.

b. The United States imports S225 of goods and for them by drawing down its foreign demand deposits.

c. The United States pays $15 to foreigners in dividends drawn on U.S. demand deposits here.

d. American tourists spend $30 overseas using traveler’s checks drawn on U.S. banks here.

e. Americans buy foreign stocks with $60, using foreign demand deposits held abroad.

f. The U.S. government sells $45 in gold for foreign demand deposits abroad. g. In a currency support operation, the U.S. government uses its foreign demand deposits to purchase $8 from private in the United States.

2. A firm with a corporate wide debt-to-equity ratio of an after-tax cost of debt of and a cost of equity capital of 15% is interested in pursuing a foreign project. The debt capacity of the project is the same as for the company as a whole, but its systematic risk is such that the required return on equity is estimated to be about 12%. The after-tax cost of debt is expected to remain at 7%. What is the project’s weighted average cost of capital? How does it compare with the parent’s WACC? (14.3)

3. IBM is considering having its German affiliate issue a 10-year, $100-million bond denominated in euros and priced to yield 7 .5%. Alternatively, IBM’s German unit can issue a dollar-denominated bond of the same size and maturity and carrying an interest rate of 6. 7%. (14.5)

a. lf the euro is forecast to depreciate by l. 7% annually, what is the expected dollar cost of the euro denominated bond? How does this compare to the cost of the dollar bond?

b. At what rate of euro depreciation will the dollar cost of the euro-denominated bond equal the dollar cost of the dollar-denominated bond?

c. Suppose IBM’s German unit faces a 35% corporate tax rate. What is the expected after-tax dollar cost of the euro-denominated bond?

4. Suppose Minnesota Machines (MM) is trying to price an export order from Russia. Payment is due 9 months after shipping. Given the risks involved, MM would like to factor its receivable without recourse. The factor will charge a monthly discount of 2% plus a fee equal to 1.5% of the face value of the receivable for the nonrecourse financing. (15.3)

a. If Minnesota Machines desires revenue of $2.5 million from the sale, after paying all factoring charges, what is the minimum acceptable price it should charge?

b. Alternatively, CountyBank has offered to discount the receivable, but with recourse, at an annual rate of 14% plus a 1% fee. What price will net MM the $2.5 million it desires to clear from the sale?

c. On the basis of your answers to Parts a and b. should Minnesota Machines discount or factor its Russian receivables? MM is competing against Nippon Machines for the order, so the higher MM’s price, the lower the probability that its bid will be accepted. What other considerations should influence MM’s decision?

5. Ford can borrow dollars at 12% or Swiss francs at 80% for l year. The peso:dollar exchange rate is expected to move from $1 Fr 1.24 currently to $1 = Fr 1.25 by year’s end. (15.10)

a. What is the expected after-tax dollar cost of borrowing dollars for one year if the Swiss corporate tax rate is 35%?

b. What is Ford’s expected after-tax dollar cost of borrowing Swiss francs for one year?

c. At what exchange rate will the after tax Swiss franc cost of borrowing dollars equal the after-tax Swiss franc cost of borrowing francs?