FNE306 International Finance

Chu Hai College of Higher Education

Spring Semester 2011-2012

Assignment 6

1. Rankine Corporation of Australia seeks to borrow US$30,000,000 in the

Eurodollar market. Funding is needed for two years. Investigation leads to three

possibilities:

a. Rankine Corporation could borrow the US$30,000,000 for two years at a

fixed 5% rate of interest.

b. Rankine Corporation could borrow the US$30,000,000 at LIBOR + 1.5%.

LIBOR is currently 3.5%, and the rate would be reset every six months.

c. Rankine Corporation could borrow the US$30,000,000 for one year only at

4.5%. At the end of the first year Rankine Corporation would have to

negotiate for a new one-year loan.

Compare the alternatives and make a recommendation.

Ans.

                     

  Rankine Corporation  

   

  Compare the alternatives and make a recommendation.  

   

  Assumptions Values  

  Principal borrowing need $30,000,000  

  Maturity needed, in years 2.00  

  Fixed rate, 2 years 5.000%  

  Floating rate, six-month LIBOR + spread  

  Current six-month LIBOR 3.500%  

  Spread 1.500%  

  Fixed rate, 1 year, then re-fund 4.500%  

   

 

First 6-

months

Second 6-

months

Third 6-

months

Fourth 6-

months  

  #1: Fixed rate, 2 years  

  Interest cost per year $1,500,000 $1,500,000  

  Certainty over access to capital Certain Certain Certain Certain  

  Certainty over cost of capital Certain Certain Certain Certain  

  #2: Floating rate, six-month LIBOR + spread  

  Interest cost per year $750,000.00 $750,000.00 $750,000.00 $750,000.00  

  Certainty over access to capital Certain Certain Certain Certain  

  Certainty over cost of capital Certain Uncertain Uncertain Uncertain  

  #3: Fixed rate, 1 year, then re-fund  

  Interest cost per year $1,350,000.00 ??? ???  

  Certainty over access to capital Certain Certain Uncertain Uncertain  

  Certainty over cost of capital Certain Certain Uncertain Uncertain  

  Only alternative #1 has a certain access and cost of capital for the full 2 year period.  

  Alternative #2 has certain access to capital for both years, but the interest costs in the final 3 of 4 periods is uncertain.  

  Alternatvie #3, possessing a lower interest cost in year 1, has no guaranteed access to capital in the second year.  

  Depending on the company’s business needs and tolerance for interest rate risk, it should choose between #1 and #2.  

                     

2. Raid Gauloises is rapidly growing French sporting goods and adventure racing

outfitter. The company has decided to borrow €20,000,000 via a Euroeuro

floating rate loan for four years. Raid must decide between two competing loan

offerings from two of its banks.

Banque de Paris has offered the four-year debt at euro LIBOR + 2.00% with an

up-front initiation fee of 1.8%. Banque de Sorbonne, however, has offered euro

LIBOR + 2.5%, a higher spread, bur with no loan initiation fees up front, for the

same term and principal. Both banks reset the interest rate at the end of each year.

Euro LIBOR is currently 4.00%. Raid’s economist forecasts that LIBOR will rise

by 0.5% each year. Banque de Sorbonne, however, officially forecasts euro

LIBOR to begin trending upward at the rate of 0.25% per year. Raid Gauloises’s

cost of capital is 11%. Which loan proposal do you recommend for Raid

Gauloises?

Ans.

                 

  Raid Gauloises  

   

  Given interest rate expectations, which loan is the best deal?  

  Expected Chg  

  Assumptions Values in LIBOR  

  Principal borrowing need €20,000,000  

  Maturity needed, in years 4.00  

  Current euro-LIBOR 4.000%  

  Banque de Paris’ spread & expectation 2.000% 0.500%  

  Banque de Paris’ initiation fee 1.800%  

  Banque de Sorbonne’s spread & expectation 2.500% 0.250%  

  Banque de Sorbonne’s initiation fee 0.000%  

   

  Raid Gauloises must evaluate both loan proposals under both potential interest rate scenarios.  

   

  Banque de Paris Loan Proposal Year 0 Year 1 Year 2 Year 3 Year 4  

  Expected interest rates & payments:  

  Expected euro-LIBOR 4.000% 4.500% 5.000% 5.500% 6.000%  

  Bank spread 2.000% 2.000% 2.000% 2.000% 2.000%  

  Interest rate 6.000% 6.500% 7.000% 7.500% 8.000%  

   

  Funds raised, net of fees €19,640,000  

  Expected interest costs €1,300,000 €1,400,000 €1,500,000 €1,600,000  

  Repayment of principal         €20,000,000  

  Total cash flows €19,640,000 €1,300,000 €1,400,000 €1,500,000 €21,600,000  

   

  All-in-cost of funds if:  

  euro-LIBOR rises 0.500% per year 7.7438%  

  euro-LIBOR rises 0.250% per year 7.1365% Found by plugging in .250% in expectations above.  

   

(Continued)

Chapter 14 

Interest Rate and C

urrency Sw

aps  

267

  Raid Gauloises (Continued)  

  Banque de Sorbonne Loan Proposal Year 0 Year 1 Year 2 Year 3 Year 4  

  Expected interest rates & payments:  

  Expected euro-LIBOR 4.000% 4.250% 4.500% 4.750% 5.000%  

  Bank spread 2.500% 2.500% 2.500% 2.500% 2.500%  

  Interest rate 6.500% 6.750% 7.000% 7.250% 7.500%  

   

  Funds raised, net of fees €20,000,000  

  Expected interest costs €1,350,000 €1,400,000 €1,450,000 €1,500,000  

  Repayment of principal         €20,000,000  

  Total cash flows €20,000,000 €1,350,000 €1,400,000 €1,450,000 €21,500,000  

   

  All-in-cost of funds if:  

  euro-LIBOR rises 0.500% per year 7.0370% Found by plugging in .500% in expectations above.  

  euro-LIBOR rises 0.250% per year 7.1036%  

   

  The Banque de Sorbonne loan proposal is actually lower all-in-cost under either interest rate scenario.  

                 

3. Citigroup regularly performs a U.S. dollar-based discount cash flow (DCF)

valuation of Petrobrás in its coverage. That DCF analysis requires the use of a

discount rate which they base on the company's weighted average cost of capital.

Evaluate the methodology and assumptions used in the 2003 Actual and 2004

Estimates of Petrobras's WACC below.

268  

Moffett • F

undamentals of M

ultinational Finance, S

econd Edition

Ans.

4. Grupo Modelo, a brewery out of Mexico that exports such well-known varieties as

Corona, Modelo and Pacifico, is Mexican by incorporation. However, the

company evaluates all business results, including financing costs, in U.S. dollars.

The company needs to borrow $10,000,000 or the foreign currency equivalent for

four years. For all issues, interest is payable once per year, at the end of the year.

Available alternatives are:

a. Sell Japanese yen bonds at par yielding 3% per annum. The current exchange

rate is ¥106/$, and the yen is expected to strengthen against the dollar by 2% per

annum.

b. Sell euro-denominated bonds at par yielding 7% per annum. The current

exchange rate is $1.1960/€, and the euro is expected to weaken against the dollar

by 2% per annum.

c. Sell U.S. dollar bonds at par yielding 5% per annum.

Which course of action do you recommend Grupo Modelo take and why?

Ans.

5. Finisterra, S.A., located in the state of Baja California, Mexico, manufactures

frozen Mexican food which enjoys a large following in the U.S. states of

California and Arizona to the north. In order to be closer to its U.S. market,

Finisterra is considering moving some of its manufacturing operations to southern

California. Operations in California would begin in Year 1 and have the following

attributes.

The operations in California will pay 80% of its accounting profit to Finisterra as

an annual cash dividend. Mexican taxes are calculated on grossed up dividends

from foreign countries, with a credit for host country taxes already paid. What is

the maximum U.S. dollar price Finisterra should offer in Year 1 for the

investment?

Ans.

6. Doohickey Devices, Inc., manufactures design components for personal

computers. Until the present, manufacturing has been subcontracted to other

companies, but for reasons of quality control Doohicky has decided to

manufacture itself in Asia. Analysis has narrowed the choice to two possibilities,

Penang, Malaysia, and Manila, the Philippines. At the moment only the following

summary of expected, after tax, cash flows is available. Although most operating

outflows would be in Malaysian ringgit or Philippine pesos, some additional U.S.

dollar cash outflows would be necessary, as shown in the table below.

The Malaysia ringgit currently trades at RM3.80/$ and the Philippine peso trades

at Ps50.00/$. Doohicky expects the Malaysian ringgit to appreciate 2.0% per year

against the dollar, and the Philippine peso to depreciate 5.0% per year against the

dollar. If the weighted average cost of capital for Doohicky Devices is 14.0%,

which project looks most promising?

Ans.