The chapter demonstrated that a firm borrowing in a foreign currency could poten

Question

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 SF1.4 ?million, a? one-year period, an initial spot rate of SF1.4800?/$, a 4.569% cost of? debt, and a 40?% tax? rate, what is the effective? after-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.SF1.4800?/$

b. SF1.4400?/$

c. SF1.3640?/$

d. SF1.5930?/$

Explanation / Answer

(a) Initial Borrowing = SF 1.4 million, Borrowing in $ = 1.4 / 1.48 = $ 0.946 million

Cost of Debt = 4.569 %

Final Value of Debt = 1.4 x 1.04569 = SF 1.464 million

End of Period Exchange Rate = SF 1.48/ $

Final Value of Debt in $ = 1.464 / 1.48 = $ 0.989 million

$ Cost of Debt = (0.989 - 0.946) / 0.946 = 0.04569 or 4.569 %

After-Tax Cost of Debt = 4.569 x (1-0.4) = 2.7414 %

(b) End of Period Exchange Rate = SF 1.44/$

Final Debt Value in $ = 1.464 / 1.44 = $ 1.0167 million

$ Cost of Debt = (1.0167 - 0.946) / 0.946 = 0.0747 or 7.47 %

After-Tax Cost of Debt = 7.47 x (1-0.4) = 4.482 %

(c)

End of Period Exchange Rate = SF 1.364/$

Final Debt Value in $ = 1.464 / 1.364 = $ 1.0733 million

$ Cost of Debt = (1.0733 - 0.946) / 0.946 = 0.1346 or 13.46 %

After-Tax Cost of Debt = 13.46 x (1-0.4) = 8.076 %

(d)

End of Period Exchange Rate = SF 1.593/$

Final Debt Value in $ = 1.464 / 1.593 = $ 0.919 million

$ Cost of Debt = (0.919 - 0.946) / 0.946 = - 0.0285 or - 2.85 %

After-Tax Cost of Debt = -2.85 x (1-0.4) = - 1.71 %

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