For example if a us based firm borrows sf1500000 for

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Microeconomics: Private and Public Choice
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Chapter ST3 / Exercise 6
Microeconomics: Private and Public Choice
Gwartney/Stroup/Sobel/Macpherson
Expert Verified
For example, if a U.S.-based firm borrows SF1,500,000 for one year at 5.00% interest, and during the year the Swiss franc appreciates from an initial rate of SF1.5000/$ to SF1.4400/$, what is the dollar cost of this debt ? The dollar proceeds of the initial borrowing are calculated at the current spot rate of SF1.5000/$:
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Microeconomics: Private and Public Choice
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Chapter ST3 / Exercise 6
Microeconomics: Private and Public Choice
Gwartney/Stroup/Sobel/Macpherson
Expert Verified
At the end of one year the U.S.-based firm is responsible for repaying the SF1,500,000 principal plus 5.00% interest, or a total of SF1,575,000. This repayment, however, must be made at an ending spot rate of SF1.4400/$: The actual dollar cost of the loan’s repayment is not the nominal 5.00% paid in Swiss franc interest, but 9.375%: The dollar cost is higher than expected due to appreciation of the Swiss franc against the U.S. dollar. This total home-currency cost is actually the result of the combined percentage cost of debt and percentage change in the foreign currency’s value. We can find the total cost of borrowing Swiss francs by a U.S.-dollar based firm, , by multiplying one plus the Swiss franc interest expense, , by one plus the percentage change in the SF/$ exchange rate, s : where = 5.00% and s = 4.1667%. The percentage change in the value of the Swiss franc versus the U.S. dollar, when the home currency is the U.S. dollar, is The total expense, combining the nominal interest rate and the percentage change in the exchange rate, is
The total percentage cost of capital is 9.375%, not simply the foreign currency interest payment of 5%. The after-tax cost of this Swiss franc denominated debt, when the U.S. income tax rate is 34%, is The firm would report the added 4.1667% cost of this debt in terms of U.S. dollars as a foreign exchange transaction loss, and it would be deductible for tax purposes. Expectations of International Portfolio Investors Chapter 13 highlighted the fact that the key to gaining a global cost and availability of capital is attracting and retaining international portfolio investors. Those investors’ expectations for a firm’s debt ratio and overall financial structures are based on global norms that have developed over the past 30 years. Because a large proportion of international portfolio investors and based in the most liquid and unsegmented capital markets, such as the United States and the United Kingdom, their expectations tend to predominate and override individual national norms. Therefore, regardless of other factors, if a firm wants to raise capital in global markets, it must adopt global norms that are close to the U.S. and U.K. norms. Debt ratios up to 60% appear to be acceptable. Higher debt ratios are more difficult to sell to international portfolio investors. Raising Equity Globally Once a multinational firm has established its financial strategy and considered its desired and target capital structure , it then proceeds to raise capital outside of its domestic market—both debt and equity—using a variety of capital raising paths and instruments.

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