1. G anado’s Cost of Capital. MariaGonzalez, Ganado’s Chief FinancialOfficer, estimates therisk-free rate to be 3.30%, thecompany’s
credit risk premium is 4.40%, the domestic beta is estimated at 1.19, the international beta is estimated at 0.99, and thecompany’s capital
structure is now 30% debt. The expected rate of return on the market portfolio held by awell-diversified domestic investor is 9.50% and
the expected return on a larger globally integrated equity market portfolio is 8.70%. Thebefore-tax cost of debt estimated by observing the
current yield onGanado’s outstanding bonds combined with bank debt is 8.00% and thecompany’s effective tax rate is 38%. For both the
domestic CAPM andICAPM, calculate thefollowing:
a. Ganado’s cost of equity
b. Ganado’s after-tax cost of debt
c. Ganado’s weighted average cost of capital
a. Using the domesticCAPM, what isGanado’s cost ofequity?
% (Round to two decimal places.)
Using theICAPM, what isGanado’s cost ofequity?
% (Round to two decimal places.)
b. Using the domesticCAPM, what isGanado’s after-tax cost ofdebt?
% (Round to two decimal places.)
Using theICAPM, what isGanado’s after-tax cost ofdebt?
% (Round to two decimal places.)
c. Using the domesticCAPM, what isGanado’s weighted average cost ofcapital?
% (Round to two decimal places.)
Using theICAPM, what isGanado’s weighted average cost ofcapital?
% (Round to two decimal places.)
2. Thunderhorse Oil. Thunderhorse Oil is a U.S. oil company. Its current cost of debt is 7.00%, and the10-year U.S. Treasuryyield, the
proxy for therisk-free rate ofinterest, is 3.60%. The expected return on the market portfolio is 7.90%. Thecompany’s effective tax rate is
42%. Its optimal capital structure is 65% debt and 35% equity.
a. IfThunderhorse’s beta is estimated at 1.30, what isThunderhorse’s weighted average cost ofcapital?
b. IfThunderhorse’s beta is estimated at 1.00, significantly lower because of the continuing profit prospects in the global energysector,
what isThunderhorse’s weighted average cost ofcapital?
a. IfThunderhorse’s beta is estimated at 1.30, what isThunderhorse’s weighted average cost ofcapital?
% (Round to two decimal places.)
b. IfThunderhorse’s beta is estimated at 1.00, significantly lower because of the continuing profit prospects in the global energysector,
what isThunderhorse’s weighted average cost ofcapital?
% (Round to two decimal places.)
3. WestGasConveyance, Inc. WestGasConveyance, Inc., is a large U.S. natural gas pipeline company that wants to raise$120 million to
finance expansion. WestGas wants a capital structure that is 50% debt and 50% equity. Its corporate combined federal and state income
tax rate is 36%. WestGas finds that it can finance in the domestic U.S. capital market at the rates listed in the popupwindow: 1. Both debt
and equity would have to be sold in multiples of$20 million, and these cost figures show the componentcosts, each, of debt and equity if
raised 50% by debt and 50% by equity. A London bank advises WestGas that U.S. dollars could be raised in Europe at the followingcosts,
also in multiples of$20 million, while maintaining the 50/50 capital structure. Each increment of cost would be influenced by the total
amount of capital raised. Thatis, if WestGas first borrowed$20 million in the European market at 5% and matched this with an
additional$20 million ofequity, additional debt beyond this amount would cost 13% in the United States and 11% in Europe. The same
relationship holds for equity financing.
a. Calculate the lowest average cost of capital for each increment of$40 million of newcapital, where WestGas raises$20 million in the
equity market and an additional$20 in the debt market at the same time.
b. If WestGas plans an expansion of only$60 million, how should that expansion befinanced?
c. What will be the weighted average cost of capital for theexpansion?
a. If WestGas plans an expansion of$120 million, what is the lowest average cost of capital for the first $40 million of newcapital?
% (Round to two decimal places.)
What is the lowest average cost of capital for the second$40 million of newcapital?
% (Round to two decimal places.)
What is the lowest average cost of capital for the third$40 million of newcapital?
% (Round to two decimal places.)
What will be the weighted average cost of capital for the$120 millionexpansion?
% (Round to two decimal places.)
b. If WestGas plans an expansion of only$60 million, what will be the weighted average cost of capital for the additional$20 million over
the first$40 million of newcapital?
% (Round to two decimal places.)
c. What will be the weighted average cost of capital for the$60 millionexpansion?
% (Round to two decimal places.)
1: Data Table
(Click on the
icon to import the table into aspreadsheet.)
Cost of
Domestic Equity
Cost of
Domestic Debt
Cost of
European Equity
Cost of
European Debt
Up to$40 million of new capital
12%
7%
14%
5%
$41 million to$80 million of new capital
17%
13%
16%
11%
Above$80 million
21%
17%
23%
19%
Costs of Raising Capital in the Market
4. Foreign Exchange Risk and the Cost of Borrowing Swiss Francs. The chapter demonstrated that a firm borrowing in a foreign
currency could potentially end up paying a very different effective rate of interest than what it expected. Using the same baseline values of
a debt principal of SF1.5 million, aone-year period, an initial spot rate of SF1.4600/$, a 5.446% cost of debt, and a 40% taxrate, what is
the effectiveafter-tax cost of debt for one year for a U.S.dollar-based company if the exchange rate at the end of the period was:
a. SF1.4600/$
b. SF1.3900/$
c. SF1.3140/$
d. SF1.5730/$
a. If the exchange rate at the end of the period was SF1.4600/$, what is the effectiveafter-tax cost ofdebt?
% (Round to four decimalplaces.)
b. If the exchange rate at the end of the period was SF1.3900/$, what is the effectiveafter-tax cost ofdebt?
% (Round to four decimalplaces.)
c. If the exchange rate at the end of the period was SF1.3140/$, what is the effectiveafter-tax cost ofdebt?
% (Round to four decimalplaces.)
d. If the exchange rate at the end of the period was SF1.5730/$, what is the effectiveafter-tax cost ofdebt?
% (Round to four decimalplaces.)
5. McDougan Associates(USA). McDouganAssociates, aU.S.-based investmentpartnership, borrows €70,000,000 at a time when the
exchange rate is $1.3472/€. The entire principal is to be repaid in threeyears, and interest is 6.650% perannum, paid annually in euros.
The euro is expected to depreciatevis-à-vis the dollar at 3.5% per annum. What is the effective cost of this loan forMcDougan?
Complete the following table to calculate the dollar cost of theeuro-denominated debt for years 0 through 3. Enter a positive number for a
cash inflow and negative for a cash outflow. (Round the amount to the nearest whole number and the exchange rate to four
decimalplaces.)
Year 0
Proceeds from borrowing euros
€
Year 1
Year 2
Year 3
70,000,000
Interest payment due in euros
€
€
€
(70,000,000)
Repayment of principal in year 3
Total cash flow of euro-denominated debt
€
Expected exchange rate, $/€
Dollar equivalent of euro-denominated cash flow
€
€
€
$
$
$
1.3472
$
What is the effective cost of this loan forMcDougan?
% (Round to two decimal places.)
6. PetrolIbérico. PetrolIbérico, a European gascompany, is borrowing $750,000,000 via a syndicated eurocredit for six years at 70 basis
points over LIBOR. LIBOR for the loan will be reset every six months. The funds will be provided by a syndicate of eight leading
investmentbankers, which will chargeup-front fees totaling 1.4% of the principal amount. What is the effective interest cost for the first
year if the annual LIBOR is 4.20% during the first six months and 4.60% during the second six months.
The effective interest cost for the first year is
%. (Round to two decimalplaces.)
7. Adamantine Architectonics. Adamantine Architectonics consists of a U.S. parent and wholly owned subsidiaries in
Malaysia(A-Malaysia) and Mexico(A-Mexico). Selected portions of theirnon-consolidated balancesheets, translated into U.S.dollars, are
shown in the popupwindow, 2. What are the debt and equity proportions inAdamantine’s consolidated balancesheet?
What is the debt proportion inAdamantine’s consolidated balancesheet?
% (Round to two decimal places.)
What is the equity proportion inAdamantine’s consolidated balancesheet?
% (Round to two decimal places.)
2: Data Table
A-Malaysia (inringgits)
A-Mexico (inpesos)
Long-term debt
RM15,840,000
Long-term debt
Ps27,500,000
Shareholders’ equity
RM18,920,000
Shareholders’ equity
Ps73,700,000
Parentlong-term debt
$18,000,000
Adamantine Architectonics (non-consolidated)
Investment in subsidiaries(US dollars):
inA-Malaysia
$4,300,000
Common stock
$6,000,000
inA-Mexico
$6,700,000
Retained earnings
$22,000,000
Current exchange rates
Malaysian ringgit per dollar
RM4.40/$
Mexican pesos per dollar
Ps11.00/$
Click on the icon located on thetop-right corner of the data table in order to copy its contents into a spreadsheet.
8. Tony Begay at Saguaro Funds. TonyBegay, a currency trader forChicago-based SaguaroFunds, uses the following futuresquotes, 1,
on the British pound (£) to speculate on the value of the pound.
a. If Tony buys 5 June poundfutures, and the spot rate at maturity is $1.3984/£, what is the value of herposition?
b. If Tony sells 12 March poundfutures, and the spot rate at maturity is $1.4564/£, what is the value of herposition?
c. If Tony buys 3 March poundfutures, and the spot rate at maturity is $1.4564/£, what is the value of herposition?
d. If Tony sells 12 June poundfutures, and the spot rate at maturity is $1.3984/£, what is the value of herposition?
a. If Tony buys 5 June poundfutures, and the spot rate at maturity is $1.3984/£, what is the value of herposition?
The value ofTony’s position is $
. (Round to the nearest cent. Use a minus sign if value isnegative.)
b. If Tony sells 12 March poundfutures, and the spot rate at maturity is $1.4564/£, what is the value of herposition?
The value ofTony’s position is $
. (Round to the nearest cent. Use a minus sign if value isnegative.)
c. If Tony buys 3 March poundfutures, and the spot rate at maturity is $1.4564/£, what is the value of herposition?
The value ofTony’s position is $
. (Round to the nearest cent. Use a minus sign if value isnegative.)
d. If Tony sells 12 June poundfutures, and the spot rate at maturity is $1.3984/£, what is the value of herposition?
The value ofTony’s position is $
. (Round to the nearest cent. Use a minus sign if value isnegative.)
1: Data Table
(Click on the icon
to import the table into aspreadsheet.)
British PoundFutures, US$/pound (CME)
Contract= 62,500 pounds
Maturity
Open
High
Low
Settle
Change
High
Open Interest
March
1.4246
1.4268
1.4214
1.4228
0.0032
1.4700
25,605
June
1.4164
1.4188
1.4146
1.4162
0.0030
1.4550
809
9. Cece Cao in Jakarta. Cece Cao trades currencies for Sumatra Funds in Jakarta. She focuses nearly all of her time and attention on the
U.S.dollar/Singapore dollar($/S$) cross rate. The current spot rate is $0.6000/S$. After considerablestudy, she has concluded that the
Singapore dollar will appreciate versus the U.S. dollar in the coming 90 days, probably to about $0.7002/S$. She has the following options
on the Singapore dollar to choosefrom: 2.
a. Should Cece buy a put on Singapore dollars or a call on Singaporedollars?
b. What isCece’s breakeven price on the option purchased in part a?
c. Using your answer from part a, what isCece’s gross profit and net profit(including premium) if the spot rate at the end of 90 days is
indeed $0.7002/S$?
d. Using your answer from part a, what isCece’s gross profit and net profit(including premium) if the spot rate at the end of 90 days is
$0.8001/S$?
a. Should Cece buy a put on Singapore dollars or a call on Singaporedollars? (Select the best choicebelow.)
A. Since Cece expects the Singapore dollar to appreciate versus the U.S.dollar, she should buy a call on Singapore dollars. This gives
open market at $0.6500/S$ each for a profit.(If her expectation of the future spot rate provescorrect.)
B. Since Cece expects the Singapore dollar to appreciate versus the U.S.dollar, she should buy a call on Singapore dollars. This gives
open market at $0.7002/S$ each for a profit.(If her expectation of the future spot rate provescorrect.)
C. Since Cece expects the Singapore dollar to appreciate versus the U.S.dollar, she should buy a put on Singapore dollars. This gives
open market at $0.7002/S$ each for a profit.(If her expectation of the future spot rate provescorrect.)
D. Since Cece expects the Singapore dollar to appreciate versus the U.S.dollar, she should buy a call on Singapore dollars. This gives
open market at $0.7002/S$ each for a profit.(If her expectation of the future spot rate provescorrect.)
b. Cece’s breakeven price is $
/S$. (Round to five decimalplaces.)
c. Cece’s grossprofit, if the spot rate at the end of 90 days is $0.7002/S$, is $
/S$. (Round to five decimalplaces.)
Cece’s net profit(including premium), if the spot rate at the end of 90 days is $0.7002/S$, is $
decimalplaces.)
d. Cece’s grossprofit, if the spot rate at the end of 90 days is $0.8001/S$, is $
/S$. (Round to five
/S$. (Round to five decimalplaces.)
Cece’s net profit(including premium), if the spot rate at the end of 90 days is $0.8001/S$, is $
/S$. (Round to five
decimalplaces.)
2: Data Table
(Click on the icon
to import the table into aspreadsheet.)
Option
Strike Price
Premium
Put(US$/Singapore dollar)
0.6500
0.00003
Call(US$/Singapore dollar)
0.6500
0.00046
10. Baker Street. Arthur Doyle is a currency trader for BakerStreet, a private investment house in London. BakerStreet’s clients are a
collection of wealthy private investorswho, with a minimum stake of £240,000 each, wish to speculate on the movement of currencies.
The investors expect annual returns in excess of 25%. Although officed inLondon, all accounts and expectations are based in U.S.
dollars.
Arthur is convinced that the British pound will slide significantly—possibly to $1.3200 / £—in the coming 30 to 60 days. The current spot
rate is $1.4263 / £. Arthur wishes to buy a put on pounds which will yield the 25% return expected by his investors. Which of the following
putoptions, 3, would you recommend hepurchase? Prove your choice is the preferable combination of strikeprice, maturity, andup-front
premium expense.
Because his expectation is for”30 to 60days” he should confine his choices to the (1)
capture the timing of the exchange rate change. (Select from thedrop-down menu.)
-day options to be sure and
The return on investment(ROI) at the strike price of $1.36/£ is
%. (Round to the nearestinteger.)
The return on investment(ROI) at the strike price of $1.34/£ is
%. (Round to the nearestinteger.)
The return on investment(ROI) at the strike price of $1.32/£ is
%. (Round to the nearestinteger.)
Arthur should purchase the60-day option at strike price $ (2)
/£. (Select from thedrop-down menu.)
3: Data Table
(Click on the icon
(1)
30
(2)
to import the table into aspreadsheet.)
Strike Price
Maturity
Premium
$1.36/£
30 days
$0.00081/£
$1.34/£
30 days
$0.00021/£
$1.32/£
30 days
$0.00004/£
$1.36/£
60 days
$0.00333/£
$1.34/£
60 days
$0.00153/£
$1.32/£
60 days
$0.00061/£
1.36
60
1.34
90
1.32
11. T-Bill Yields 2009. The interest yields on U.S. Treasury securities in early 2009 fell to very low levels as a result of the combined events
surrounding the global financial crisis. Calculate the simple and annualized yields for the3-month and6-month Tresury bills auctioned on
March9, 2009, listed here.
3-Month T-Bill
6-Month T-Bill
Treasurybill, face value
$10,000.00
$10,000.00
$9,993.97
$9,976.72
Price at sale
$6.03
$23.28
Discount
(Click the icon on theupper-right corner to import the table into aspreadsheet.)
The simple yield for the3-month Treasury bills is
%. (Round to four decimalplaces.)
The simple yield for the6-month Treasury bills is
%. (Round to four decimalplaces.)
The annualized yield for the3-month Treasury bills is
%. (Round to four decimalplaces.)
The annualized yield for the6-month Treasury bills is
%. (Round to four decimalplaces.)
12. CB Solutions. HeatherO’Reilly, the treasurer of CBSolutions, believes interest rates are going torise, so she wants to swap her
futurefloating-rate interest payments for fixed rates.Presently, she is paying per annum on $5,000,000 of debt for the next twoyears, with
payments due semiannually. LIBOR is currently 3.983% per annum. Spread paid overLIBOR, per annum is 2.000%. Heather has just
made an interest paymenttoday, so the next payment is due six months from now. Heather finds that she can swap her
currentfloating-rate payments for fixed payments of 7.004% per annum.(CB Solutions’ weighted average cost of capital is 12%, which
Heather calculates to be 6% per6-month period, compoundedsemiannually).
a. If LIBOR rises at the rate of 50 basis points per6-month period, startingtomorrow, how much does Heather save or cost her company
by making thisswap?
b. If LIBOR falls at the rate of 25 basis points per6-month period, startingtomorrow, how much does Heather save or cost her company
by making thisswap?
a. If LIBOR rises at the rate of 50 basis points per6-month period, startingtomorrow, how much does Heather save or cost her company
by making thisswap?
for the firstsix-month period is $
The swap (1)
. (Select from thedrop-down menu and round to the
nearestdollar.)
The swap (2)
nearestdollar.)
for the secondsix-month period is $
. (Select from thedrop-down menu and round to the
The swap (3)
nearestdollar.)
for the thirdsix-month period is $
. (Select from thedrop-down menu and round to the
The swap (4)
for the fourthsix-month period is $
. (Select from thedrop-down menu and round to the
nearestdollar.)
b. If LIBOR falls at the rate of 25 basis points per6-month period, startingtomorrow, how much does Heather save or cost her company
by making thisswap?
The swap (5)
nearestdollar.)
for the firstsix-month period is $
. (Select from thedrop-down menu and round to the
The swap (6)
for the secondsix-month period is $
. (Select from thedrop-down menu and round to the
nearestdollar.)
The swap (7)
nearestdollar.)
for the thirdsix-month period is $
. (Select from thedrop-down menu and round to the
The swap (8)
nearestdollar.)
for the fourthsix-month period is $
. (Select from thedrop-down menu and round to the
(1)
cost
(2)
savings
(7)
cost
savings
cost
savings
(8)
cost
savings
(3)
cost
savings
(4)
cost
savings
(5)
cost
savings
(6)
cost
savings
13. Sovereign Debt Negotiations. A sovereign borrower is considering a $100 million loan for a 4-year maturity. It will be an amortizingloan,
meaning that the interest and principal payments willtotal, annually, to a constant amount over the maturity of the loan. Thereis, however,
a debate over the appropriate interest rate. The borrower believes the appropriate rate for its current credit standing in the market today is
8%, but a number of international banks with which it is negotiating are arguing that is most likely 13%, at the minimum 8%. What impact
do these different interest rates have on the prospective annualpayments?
The annualpayment, if the interest rate was 8%, is $
. (Round to the nearestdollar.)
The annualpayment, if the interest rate was 13%, is $
. (Round to the nearestdollar.)
What impact do these different interest rates have on the prospective annualpayments? (Round to the nearest dollar and select from
thedrop-down menus.)
. This is a modest increase in the annualpayment, given the short maturity
The difference in the annual payment is $
of the obligation.However, if you are a (1)
, every cost reduction matters. If you are a sovereign (2)
which is heavily indebted and in a position of a potentialdefault, an interest rate increase of this amount could be critical.
(1)
borrower
(2)
lender
borrower
lender
14. Lluvia and Paraguas. Lluvia Manufacturing and Paraguas Products both seek funding at the lowest possible cost. Lluvia would prefer the
flexibility offloating-rate borrowing, while Paraguas wants the security offixed-rate borrowing. Lluvia is the more creditworthy company.
They face the following rate structure.Lluvia, with the better creditrating, has lower borrowing costs in both types of borrowing. Lluvia
wantsfloating-rate debt, so it could borrow at LIBOR + 1.000%. However, it could borrow fixed at 8.500% and swap forfloating-rate debt.
Paraguas wantsfixed-rate debt, so it could borrow fixed at 12.500%. However, it could borrow floating at LIBOR + 2.000% and swap
forfixed-rate debt. What should theydo? (LIBOR is 5.500%.)
Lluvia’s comparative advantage is
%. (Round to three decimalplaces.)
Lluvia’s net interest after a swap with Paraguas is
%. (Round to three decimalplaces.)
Paraguas’s net interest after a swap with Lluvia is
%. (Round to three decimalplaces.)
Lluvia’s savings on borrowing versus net swap is
%. (Round to three decimalplaces.)
Paraguas’s savings on borrowing versus net swap is
Therefore, Lluvia should borrow at the (1)
from thedrop-down menus.)
(1)
fixed
floating
(2)
fixed
floating
%. (Round to three decimalplaces.)
rate and Paraguas should borrow at the (2)
rate. (Select
15.Carambola de Honduras. Slinger Wayne, a U.S.-based private equity firm, is trying to determine what it should pay for a tool
manufacturing firm in Honduras named Carambola. Slinger Wayne estimates that Carambola will generate a free cash flow of 13 million
Honduran lempiras(Lp) nextyear, and that this free cash flow will continue to grow at a constant rate of 8.5% per annum indefinitely.
A private equity firm like SlingerWayne, however, is not interested in owning a company forlong, and plans to sell Carambola at the end of
three years for approximately 10 timesCarambola’s free cash flow in that year. The current spot exchange rate is Lp15.6705/$, but the
Honduran inflation rate is expected to remain at a relatively high rate of 17.0% per annum compared to the U.S. dollar inflation rate of only
3.5% per annum. Slinger Wayne expects to earn at least a 21.5% annual rate of return on international investments like Carambola.
a. What is Carambola worth if the Honduran lempira were to remain fixed over thethree-year investmentperiod?
b. What is Carambola worth if the Honduran lempira were to change in value over time according to purchasing powerparity?
a. Calculate the free cash flows in Honduran lempiras(Lp) below: (Round to the nearest wholenumber.)
Year 0
Carambola’s expected free cash flow
Year 1
Lp
Year 2
13,000,000 Lp
Lp
Expected sale value in year 3
Lp
Total expected cash flow
Expected exchange rate (Lp/$)
Year 3
Lp
Lp
Lp
15.6705
Carambola’s expected cash flow in US$
Assume that the Honduran lempira were to remain fixed over thethree-year investment period. Calculate the free cash flows in U.S.
dollarsbelow: (Round to the nearestdollar.)
Year 0
Year 1
Year 2
Year 3
Carambola’s expected free cash flow
Expected sale value in year 3
Total expected cash flow
Expected exchange rate (Lp/$)
15.6705
Carambola’s expected cash flow in US$
15.6705
$
15.6705
$
15.6705
$
If Slinger Wayne expects to earn at least a 21.5% annual rate of return on internationalinvestments, the value of Carambola today is
$
. (Round to the nearestdollar.)
b. Assume that the Honduran lempira were to change in value over time according to purchasing power parity. Calculate the spot
exchange rates for the next three yearsbelow: (Round to four decimalplaces.)
Year 0
Carambola’s expected free cash flow
Year 1
Lp
13,000,000
Expected sale value in year 3
Total expected cash flow
Expected exchange rate (Lp/$)
15.6705
Carambola’s expected cash flow in US$
Calculate the free cash flows in U.S. dollarsbelow: (Round to the nearestdollar.)
Year 2
Year 3
Year 0
Carambola’s expected free cash flow
Year 1
Lp
Year 2
Year 3
13,000,000
Expected sale value in year 3
Total expected cash flow
Expected exchange rate (Lp/$)
Carambola’s expected cash flow in US$
15.6705
$
$
$
If Slinger Wayne expects to earn at least a 21.5% annual rate of return on internationalinvestments, the value of Carambola today is
$
. (Round to the nearestdollar.)
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