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, a one-year period, an initial spot rate of SF1.4600/$, a 5.302% cost of debt, and a 38% tax rate, what is the effective after-tax cost of debt for one year for a U.S. dollar-based company if the exchange rate at the end of the period was:
a. SF1.4600/$
b. SF1.4100/$
c. SF1.3670/$
d. SF1.5840/$
Round to four decimal places
Debt principal(Swiss francs)=1,500,000
Initial spot rate(s1)=1.4600
Cost of debt=5.302%
Tax rate=38.00%
a. If the exchange remains the same= 1.4600
We first calculate the percentage change in the exchange rate, s = ( S1 - S2 ) / (S2)x100 =1.46-1.46 /1.46 x100=0.000%
We then calculate the effective cost of debt after exchange rate changes=5.302%
b. If the exchange ends the period at SF1.4100/$:
We first calculate the percentage change in the exchange rate, s = ( S1 - S2 ) / (S2)x100 =1.46-1.41 /1.41 x100=3.5461%
We then calculate the effective cost of debt after exchange rate changes
kd= [ ( 1 + kd in SF) x ( 1 + s ) ]- 1 =[(1+.05302)x(1+0.03546)]-1=9.0360%
c. If the exchange ends the period at SF1.3670/$:
We first calculate the percentage change in the exchange rate, s = ( S1 - S2 ) / (S2)x100=6.8032%
We then calculate the effective cost of debt after exchange rate changes
kd= [ ( 1 + kd in SF) x ( 1 + s ) ]- 1 =[(1+.05392)x(1+0.068032)]-1=12.5620%.
d.
If the exchange ends the period at SF1.5840/$:
We first calculate the percentage change in the exchange rate, s = ( S1 - S2 ) / (S2)x100=-7.8283%
We then calculate the effective cost of debt after exchange rate changes
kd= [ ( 1 + kd in SF) x ( 1 + s ) ]- 1
=[(1+.05302)x(1-0.078283)]-1=-2.9413%
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