Corporate Finance, 4e, Global Edition (Berk / DeMarzo)
Chapter 31 International Corporate Finance
31.1 Internationally Integrated Capital Markets
Use the following information to answer the question(s) below.
Rearden Metal, a U.S. manufacturer, has made a purchase from d’Anconia Copper and is expecting a
cash outflow of 2 million ARS (Argentine Pesos) in six months. The currency spot rate is $0.2500/ARS
and the six-month forward rate is F6months = $0.2470/ARS. The appropriate annual discount rate for
the Argentine Peso is 6.5% and the annual discount rate for the U.S. dollar is 4%.
1) The present value of Rearden Metal’s cash outflow computed by first discounting the cash flow at the
appropriate Argentine Peso rate and then converting to dollars is closest to:
A) $469,500
B) $475,000
C) $481,000
D) $484,500
2) The present value of Rearden Metal’s cash outflow computed by first converting to dollars and then
discounting the cash flow at the appropriate Argentine Peso rate is closest to:
A) $469,500
B) $475,000
C) $481,000
D) $484,500
3) What conclusions can you make about the degree of international integration between the U.S. and
Argentine markets?
A) The markets are integrated since the PV of investing dollars today and converting them with a
forward contract is significantly less than converting into Pesos today and investing those Pesos for six
months.
B) The markets are integrated since the PV of investing dollars today and converting them with a
forward contract is significantly greater than converting into Pesos today and investing those Pesos for
six months.
C) The markets are integrated since the PV of investing dollars today and converting them with a
forward contract is approximately equal to converting into Pesos today and investing those Pesos for six
months.
D) The markets are not integrated since the PV of investing dollars today and converting them with a
forward contract is greater than converting into Pesos today and investing those Pesos for six months.
4) Which of the following statements regarding international projects is FALSE?
A) Interest rates and costs of capital will likely be different in the foreign country as a result of the
macroeconomic environment.
B) The project will most likely generate foreign currency cash flows, although the firm cares about the
foreign currency value of the project.
C) Under internationally integrated capital markets, the value of an investment does not depend on the
currency we use in the analysis.
D) The firm will probably face a different tax rate in the foreign country and will be subject to both
foreign and domestic tax codes.
5) Consider the following equation:
S × =
The term F in this equation is:
A) the future spot exchange rate.
B) the current spot exchange rate.
C) the amount of foreign currency.
D) the forward exchange rate.
6) Consider the following equation:
S × =
The term S in this equation is:
A) the forward exchange rate.
B) the amount of foreign currency.
C) the future spot exchange rate.
D) the current spot exchange rate.
7) Consider the following equation:
S × =
The term in this equation is:
A) the appropriate cost of capital from the standpoint of a U.S. investor.
B) the risk-free rate for a foreign investor.
C) the risk-free rate for a U.S. investor.
D) the appropriate cost of capital from the standpoint of a foreign investor.
8) Consider the following equation:
S × =
The term in this equation is:
A) the risk-free rate for a foreign investor.
B) the risk-free rate for a U.S. investor.
C) the appropriate cost of capital from the standpoint of a foreign investor.
D) the appropriate cost of capital from the standpoint of a U.S. investor.
Use the information for the question(s) below.
You are a U.S. investor who is trying to calculate the present value of £5 million cash inflow that will
occur one year in the future. The spot exchange rate is S = $1.8839/£ and the forward rate is F1 =
$1.8862/£. The appropriate dollar discount rate for this cash flow is 5.32% and the appropriate £
discount rate is 5.24%.
9) The present value of the £5 million cash inflow computed by first discounting the £s and then
converting into dollars is closest to:
A) $8,961,420
B) $8,950,495
C) $8,954,615
D) $8,943,695
10) The present value of the £5 million cash inflow computed by first converting into dollars and then
discounting is closest to:
A) $8,950,495
B) $8,954,615
C) $8,943,695
D) $8,961,420
31.2 Valuation of Foreign Currency Cash Flows
1) The dollar cost of debt for John Galt Industries is 8.0%. The firm faces a tax rate of 40% on all income,
no matter where it is earned. Galt needs to know its Yen cost of debt. The risk-free interest rates on
dollars and yen are r% = 6% and r¥ = 2%, respectively. Galt is willing to assume that capital markets are
internationally integrated and that its free cash flows are uncorrelated with the yen-dollar spot rate.
Galt’s after-tax cost of debt in yen is closest to:
A) 0.9%
B) 2.0%
C) 3.9%
D) 4.8%
Use the following information to answer the question(s) below.
Hammond Motors is considering an investment in the Euro area. The expected free cash flows, in
Euros, are uncorrelated with the spot exchange rate and are as follows:
Year
0
1
2
3
4
The new project, which Hammond is considering, has similar dollar risk to Hammond’s other projects.
Hammond knows that its overall dollar WACC is 10%, so it feels comfortable using this WACC for the
project. The risk-free interest rate on dollars is 4% and the risk-free interest rate on Euros is 6%.
Hammond is willing to assume that capital markets in the United States and the Euro area are
internationally integrated.
2) Hammond’s Euro WACC is closest to:
A) 7.9%
B) 8.7%
C) 10.2%
D) 12.1%
3) The NPV of this project in Euros is closest to:
A) €54 million
B) €57 million
C) €62 million
D) €65 million
4) Which of the following statements is FALSE?
A) If the foreign project is owned by a domestic corporation, managers and shareholders need to
determine the home currency value of the foreign currency cash flows.
B) The most obvious difference between a domestic project and a foreign project is that the foreign
project will most likely generate cash flows in a foreign currency.
C) The risk of the foreign project is unlikely to be exactly the same as the risk of domestic projects (or the
firm as a whole), because the foreign project contains residual exchange rate risk that the domestic
projects often do not contain.
D) In an internationally integrated capital market, two equivalent methods are available for calculating
the NPV of a foreign project: Either we can calculate the NPV in the foreign country and convert it to
the local currency at the forward rate, or we can convert the cash flows of the foreign project into the
local currency and then calculate the NPV of these cash flows.
5) Consider the following equation:
= (1 + ) – 1
the term r¥ in this equation refers to:
A) the cost of capital for the firm in terms of yen.
B) the risk-free rate of interest on the dollar.
C) the cost of capital in terms of dollars.
D) the risk-free rate of interest on the yen.
6) Consider the following equation:
= (1 + ) – 1
the term in this equation refers to:
A) the cost of capital in terms of dollars.
B) the risk-free rate of interest on the yen.
C) the risk-free rate of interest on the dollar.
D) the cost of capital for the firm in terms of yen.
7) Consider the following equation:
= (1 + ) – 1
the term in this equation refers to:
A) the risk-free rate of interest on the dollar.
B) the risk-free rate of interest on the yen.
C) the cost of capital for the firm in terms of yen.
D) the cost of capital in terms of dollars.
8) Consider the following equation:
= (1 + ) – 1
the term r$ in this equation refers to:
A) the cost of capital for the firm in terms of yen.
B) the cost of capital in terms of dollars.
C) the risk-free rate of interest on the dollar.
D) the risk-free rate of interest on the yen.
Use the information for the question(s) below.
The current spot exchange rate, S, is $1.8862/£. Suppose that the yield curve in both countries is flat.
The risk-free rate on dollars, r$, is 5.35% and the risk-free interest rate on pounds, r£, is 4.80%.
9) Using the covered interest parity condition, the calculated one-year forward rate F1 is closest to:
A) $1.8568/£
B) $1.8764/£
C) $1.9161/£
D) $1.8961/£
10) Using the covered interest parity condition, the calculated three-year forward rate F3 is closest to:
A) $1.8568/£
B) $1.9161/£
C) $1.8961/£
D) $1.8764/£
11) Luther Industries, a U.S. firm, is considering an investment in Japan. The dollar cost of equity for
Luther is 12%. The risk-free interest rates on dollars and yen are r$ = 5.5% and r¥ = 1.5% respectively.
Luther industries is willing to assume that capital markets are internationally integrated. Luther
Industries needs to know the comparable cost of equity in Japanese yen for a project with free cash
flows that are uncorrelated with spot exchange rates. The yen cost of equity for Luther Industries is
closest to:
A) 14.0%
B) 12.3%
C) 7.8%
D) 18.5%
11
Copyright © 2017 Pearson Education, Ltd.
Use the information for the question(s) below.
Luther Industries, a U.S. Corporation, is considering a new project located in Great Britain. The
expected free cash flows from the project are detailed below:
Year
Free Cash
Flow (£
millions)
0
–20
1
10
2
14
3
18
You know that the spot exchange rate is S = 1.8862/£. In addition, the risk-free interest rate on dollars
and pounds is 5.4% and 4.6% respectively. Assume that these markets are internationally integrated
and the uncertainty in the free cash flow is not correlated with uncertainty in the exchange rate. You
have determined that the dollar WACC for these cash flows is 10.2%.
12) Calculate the pound denominated cost of capital for Luther’s project.
13) What is the pound present value of the project?
14) What is the dollar present value of the project?
31.3 Valuation and International Taxation
1) Which of the following statements is FALSE?
A) U.S. tax policy requires U.S. corporations to pay taxes on their foreign income at the same rate as
profits earned in the United States.
B) The home government gets an opportunity to tax the income from a foreign project to the domestic
firm.
C) The general international arrangement prevailing with respect to taxation of corporate profits is that
the home country gets the first opportunity to tax income.
D) The home government must establish a tax policy specifying its treatment of foreign income and
foreign taxes paid on that income.
2) Which of the following statements is FALSE?
A) If the foreign tax rate exceeds the U.S. tax rate, companies must pay this higher rate on foreign
earnings.
B) U.S. tax policy allows companies to apply the part of the tax credit that is not used to offset domestic
taxes owed, so this extra tax credit is not wasted.
C) If the foreign tax rate is less than the U.S. tax rate, the company pays total taxes equal to the U.S. tax
rate on its foreign earnings.
D) A full tax credit is given for foreign taxes paid up to the amount of the U.S. tax liability.
3) Which of the following statements is FALSE?
A) If the U.S. tax rate exceeds the combined tax rate on all foreign income, it is valid to assume that the
firm pays the same tax rate on all income no matter where it is earned.
B) Firms can lower their taxes by pooling multiple foreign projects and accelerating the repatriation of
earnings.
C) Under U.S. tax law, multinational corporations may use any excess tax credits generated in high-tax
foreign countries to offset their net U.S. tax liabilities on earnings in low–tax foreign countries.
D) If the foreign tax rate exceeds the U.S. tax rate, because the U.S. tax credit exceeds the amount of U.S.
taxes owed, no tax is owed in the United States.
4) Which of the following statements is FALSE?
A) When the foreign tax rate is less than the U.S. tax rate, deferral can provide significant benefits.
B) The U.S. tax liability is not incurred until the profits are brought back home if the foreign operation is
set up as a foreign branch rather than as a separately incorporated subsidiary.
C) If a company chooses not to repatriate £12.5 million in pre-tax earnings, for example, it effectively
reinvests those earnings abroad and defers its U.S. tax liability.
D) When the foreign tax rates exceed the U.S. tax rates, there are no benefits to deferral because in such
a case there is no additional U.S. tax liability.
5) Which of the following statements is FALSE?
A) Other benefits from deferral arise because the firm effectively gains a real option to repatriate income
at times when repatriation might be cheaper.
B) By pooling foreign income, the firm effectively pays the combined tax rate on all foreign income.
C) In years in which the U.S. tax rate exceeds the combined tax rate on all foreign income, the
repatriation of additional income does not incur an additional U.S. tax liability, so the earnings can be
repatriated tax free.
D) Deferring repatriation of earnings lowers the overall tax burden in much the same way as deferring
capital gains lowers the tax burden imposed by the capital gains tax.
Use the information for the question(s) below.
KT Enterprises, a U.S. import-export trading company, is considering its international tax situation.
Currently KT’s U.S. tax rate is 35%. KT has significant operations in both Japan and Ireland. In Japan
the current exchange rate is ¥118.4/$ and earnings in Japan are taxed at 41%. In Ireland the current
exchange rate is $1.27/€ and earnings in Ireland are taxed at 12.5%. KT’s profits, which are fully and
immediately repatriated, and foreign taxes paid for the current year are shown here (in millions):
Japan
Ireland
Earnings before interest and taxes (EBIT)
¥5,920
€32
Host country taxes paid
¥2,427
€4
Earnings before interest after taxes
¥3,493
€28
6) After the Japanese taxes are paid, the amount of the earnings before interest and after taxes in dollars
from the Japanese operations is closest to:
A) $20.5 million
B) $29.5 million
C) $5.1 million
D) $50.0 million
7) After the Irish taxes are paid, the amount of the earnings before interest and after taxes in dollars
from the Ireland operations is closest to:
A) $5.1 million
B) $20.5 million
C) $35.6 million
D) $29.5 million
8) The amount of the taxes paid in dollars for the Japanese operations is closest to:
A) $29.5 million
B) $5.1 million
C) $50.0 million
D) $20.5 million
9) The amount of the taxes paid in dollars for the Irish operations is closest to:
A) $20.5 million
B) $5.1 million
C) $29.5 million
D) $50.0 million
10) Luther Industries, a U.S. firm. has a subsidiary in the United Kingdom. This year, the subsidiary
reported and repatriated earnings before interest and taxes (EBIT) of £45 million. The current exchange
rate is $1.86/£. The tax rate in the U.K. for this activity is 28%. Under U.S. tax codes, Luther is facing a
35% corporate tax rate on their earnings. What is Luther’s U.S. tax liability on its U.K. subsidiary?
31.4 Internationally Segmented Capital Markets
Use the following information to answer the question(s) below.
Incorporated Tool, a U.S. firm, is considering its international tax situation. The corporate tax rate in the
U.S. is currently 39%. Incorporated Tool has major operations in Ireland, where the tax rate is 12.5%,
Japan where the tax rate is 40.7%, and Mexico, where the tax rate is 30.0%. Incorporated Tool’s profits,
which are fully and immediately repatriated, and foreign taxes paid for the current year are as follows:
Ireland
Japan
Mexico
Earnings before interest and taxes (EBIT)
$400.0
$200.0
$100
Host country taxes paid
$50.0
$81.4
$30.0
Earnings before interest after taxes
$350.0
$118.6
$70.0
1) Assuming that the Japanese and Mexican subsidiaries did not exist, the U.S. tax liability on the Irish
subsidiary would be closest to:
A) $81 million
B) $103 million
C) $106 million
D) $156 million
2) Assuming that the Irish and Mexican subsidiaries did not exist, the U.S. tax liability on the Japanese
subsidiary would be closest to:
A) $0
B) $81 million
C) $103 million
D) $106 million
3) Assuming that the Irish and Japanese subsidiaries did not exist, the U.S. tax liability on the Mexican
subsidiary would be closest to:
A) $0
B) $9 million
C) $39 million
D) $106 million
4) Incorporated Tools total U.S. tax liability on its foreign earnings is closest to:
A) $0
B) $81 million
C) $106 million
D) $112 million
5) Which of the following statements is FALSE?
A) In some countries, especially in the developing world, all investors do not have equal access to
financial securities.
B) Firms may face differential access to markets if there is any kind of asymmetry with respect to
information about them.
C) In some cases, a country’s risk-free securities are internationally integrated but markets for a specific
firm’s securities are not.
D) When countries’ capital markets are not integrated we call them disintegrated capital markets.
6) Which of the following statements is FALSE?
A) Differential access to national capital markets is common enough that it provides the best
explanation for the existence of currency swaps, which are like the interest rate swap contracts, but with
the holder receiving coupons in one currency and paying coupons denominated in a different currency.
B) Currency swaps generally also have final face value payments, also in different currencies.
C) Using a currency swap, a firm can borrow in the market where it has the best access to capital, and
then “swap” the coupon and principal payments to whichever currency it would prefer to make
payments in.
D) With differential access to national markets, to maximize shareholder value, the firm should raise
capital in the foreign market; the method of valuing the foreign project as if it were a domestic project
would then provide the correct NPV.
7) Which of the following statements is FALSE?
A) Many countries regulate or limit capital inflows or outflows, and many do not allow their currencies
to be freely converted into dollars, thereby creating capital market segmentation.
B) The existence of internationally integrated capital markets makes many decisions in international
corporate finance more complicated but potentially more lucrative for a firm that is well positioned to
exploit the market segmentation.
C) Political, legal, social, and cultural characteristics that differ across countries may require
compensation in the form of a country risk premium.
D) Swaps allow firms to mitigate their exchange rate risk exposure between assets and liabilities, while
still making investments and raising funds in the most attractive locales.
8) Which of the following statements is FALSE?
A) The rate of interest paid on government bonds or other securities in a country with a tradition of
weak enforcement of property rights is likely not really a risk-free rate. Instead, interest rates in the
country will reflect a risk premium for the possibility of default, so relations such as covered interest
rate parity will likely not hold exactly.
B) If the return difference in a segmented financial market results from a market friction such as capital
controls, corporations can exploit this friction by setting up projects and raising capital in the high–
return country/currency.
C) Important macroeconomic reasons for segmented capital markets include capital controls and
foreign exchange controls that create barriers to international capital flows and thus segment national
markets.
D) A segmented financial market has an important implication for international corporate finance: One
country or currency has a higher rate of return than another country or currency, when the two rates are
compared in the same currency.
9) Suppose the interest rate on Russian government bonds is 7.8%, and the current exchange rate is 26.8
rubles per dollar. If the forward exchange rate is 27.2 rubles per dollar, and the current U.S. risk-free
interest rate is 4.6%, what is the implied credit spread for the Russian government bonds?
31.5 Capital Budgeting with Exchange Risk
1) What conditions cause the cash flows of a foreign project to be affected by exchange rate risk?
2) How do we make adjustments when a project has inputs and outputs in different currencies?