On September 30, 2017, Ericson Company negotiated a two-year, 1,800,000 dudek lo
ID: 2530839 • Letter: O
Question
On September 30, 2017, Ericson Company negotiated a two-year, 1,800,000 dudek loan from a foreign bank at an interest rate of 4 percent per year. It makes interest payments annually on September 30 and will repay the principal on September 30, 2019. Ericson prepares U.S.-dollar financial statements and has a December 31 year-end.
Taking the exchange rate effect on the cost of borrowing into consideration, determine the effective interest rate in dollars on the loan in each of the three years 2017, 2018, and 2019.
Effective Cost of Borrowing201720182019
September 30, 2017 $ 0.180 December 31, 2017 0.185 September 30, 2018 0.200 December 31, 2018 0.205 September 30, 2019 0.230Explanation / Answer
Using the formula for Effective Cost of Borrowing:
Rf = (1 + if)(1 + ef) - 1 Where
ef = is the expected (percentage) change in the foreign currency against the firm’s home currency.
Expected change = (forecast - current)/current), or
Forecast currenct rate for2019=$0.23
Current currency rate2017=$0.18
0.277778 0r 27.78%
Now EBC for 2017 =
0.328889 or 32.89%
Now EBC for 2018
ef=
(0.23-0.2)/0.2 =0.15
EBCfor 2018
=0.1960 or 19.60%
and for 2019 = 4.00%
Rf = (1 + if)(1 + ef) - 1 Where
Rf = is the effective financing rate. if = is the market interest rate. I.e., 4% P.A.ef = is the expected (percentage) change in the foreign currency against the firm’s home currency.
Expected change = (forecast - current)/current), or
Forecast currenct rate for2019=$0.23
Current currency rate2017=$0.18
=(0.23-0.18)/0.18 =0.277778 0r 27.78%
Now EBC for 2017 =
(1+0.04)X(1+0.277778)-1 =0.328889 or 32.89%
Now EBC for 2018
ef=
(0.23-0.2)/0.2 =0.15
EBCfor 2018
=(1+0.04)X(1+0.15)-1=0.1960 or 19.60%
and for 2019 = 4.00%
Effective Cost of Borrowing 2017 32.89% 2018 19.60% 2019 4.00%Related Questions
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