fne306 assignment 6 ans
TRANSCRIPT
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.