TropiKana Inc., a U.S firm, has just borrowed euro 1,000,000 to make improvement

Question

TropiKana Inc., a U.S firm, has just borrowed euro 1,000,000 to make improvements to an Italian fruit plantation and processing plant. If the interest rate is 3.50% per year and the Euro

a) depreciates against the dollar from $1.45/€ at the time the loan was made to $1.35/€ at the end of the first year, how much interest will TropiKana pay at the end of the first year (rounded)? Please show calculation

b) appreciates against the dollar from $1.35/€ at the time the loan was made to $1.45/€ at the end of the first year, how much interest and principle will TropiKana pay at the end of the first year if they repay the entire loan plus interest (rounded)? Please show calculation

c) appreciates against the dollar from $1.35/€ at the time the loan was made to $1.45/€ at the end of the first year, what is the before tax cost of capital if the firm repays the entire loan plus interest (rounded)? Please show calculation

Explanation / Answer

.a) Amount of loan=Euro 1,000,000

Amount in dollar=1000000*1.45=$1,450,000

Interest rate=3.50%

Amount of interest in Euro=1000000*0.035= € 35,000

Exchange rate=$1.35/ €

Interest paid in dollar=35000*1.35= $ 47,250

.b) Amount of loan=Euro 1,000,000

Amount in dollar=1000000*1.35=$1,350,000

Interest rate=3.50%

Amount of interest in Euro=1000000*0.035= € 35,000

Amount of interest in dollar=35000*1.45= $ 50,750.

Amount to be paid for principle=1.45*1000000=$1,450,000

Total amount to be paid (Principle+Interest)=1450000+50750= $ 1,500,750

.c) Cost of Capital(Before tax)

Amount borrowed in dollar=$1,350,000

Amount paid along with principle=$1,500,750

Cost of capital =(1500750/1350000)-1=0.1117

Cost of capital=11.17%

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