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Exam
Name___________________________________
MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.
1)
Consider the following equation:
r*
¥=1 +r¥
1 +r$(1 +r*
$) - 1
the term r¥ in this equation refers to
1)
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 yen.
D)
the risk-free rate of interest on the dollar.
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 rat on pounds, r£, is 4.80%.
2)
Using the covered interest parity condition, the calculated one-year forward rate F1 is closest to:
2)
A)
$1.8961/£
B)
$1.8568/£
C)
$1.9161/£
D)
$1.8764/£
3)
Which of the following statements is false?
3)
A)
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.
B)
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.
C)
Currency swaps generally also have final face value payments, also in different currencies.
D)
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.
4)
Which of the following statements is false?
4)
A)
By pooling foreign income, the firm effectively pays the combined tax rate on all foreign
income.
B)
Other benefits from deferral arise because the firm effectively gains a real option to repatriate
income at times when repatriation might be cheaper.
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.
5)
Which of the following statements is false?
5)
A)
Firms can lower their taxes by pooling multiple foreign projects and accelerating the
repatriation of earnings.
B)
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.
C)
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.
D)
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.
6)
Which of the following statements is false?
6)
A)
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.
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)
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.
7)
Consider the following equation:
S ×CFC
(1 +r*
FC)
=F × CFC
(1 +r*
$)
The term S in this equation is
7)
A)
the current spot exchange rate.
B)
the amount of foreign currency.
C)
the future spot exchange rate.
D)
the forward exchange rate.
8)
Which of the following statements is false?
8)
A)
The general international arrangement prevailing with respect to taxation of corporate profits
is that the home country gets the first opportunity to tax income.
B)
The home government must establish a tax policy specifying its treatment of foreign income
and foreign taxes paid on that income.
C)
U.S. tax policy requires U.S. corporations to pay taxes on their foreign income at the same rate
as profits earned in the United States.
D)
The home government gets an opportunity to tax the income from a foreign project to the
domestic firm.
9)
Which of the following statements is false?
9)
A)
Swaps allow firms to mitigate their exchange rate risk exposure between assets and liabilities,
while still making investments and raising funds in the most attractive locales.
B)
The existence of internationally integrated capital markets makes many decisions in
international corporate finance more complicated but potentially more lucrative for a firm
that is well positioned to exploit the market segmentation.
C)
Political, legal, social, and cultural characteristics that differ across countries may require
compensation in the form of a country risk premium.
D)
Many countries regulate or limit capital inflows or outflows, and many do not allow their
currencies to be freely converted into dollars, thereby creating capital market segmentation.
10)
Consider the following equation:
r*
¥=1 +r¥
1 +r$(1 +r*
$) - 1
the term r$ in this equation refers to
10)
A)
the risk-free rate of interest on the yen.
B)
the risk-free rate of interest on the dollar.
C)
the cost of capital in terms of dollars.
D)
the cost of capital for the firm in terms of yen.
11)
Which of the following statements is false?
11)
A)
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.
B)
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.
C)
If the foreign tax rate exceeds the U.S. tax rate, companies must pay this higher rate on foreign
earnings.
D)
A full tax credit is given for foreign taxes paid up to the amount of the U.S. tax liability.
12)
Which of the following statements is false?
12)
A)
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.
B)
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.
C)
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.
D)
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.
13)
Consider the following equation:
S ×CFC
(1 +r*
FC)
=F × CFC
(1 +r*
$)
The term r*
$ in this equation is
13)
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%.
14)
The present value of the £5 million cash inflow computed by first converting into dollars and then
discounting is closest to:
14)
A)
$8,961,420
B)
$8,954,615
C)
$8,950,495
D)
$8,943,695
15)
Consider the following equation:
r*
¥=1 +r¥
1 +r$(1 +r*
$) - 1
the term r*
¥ in this equation refers to
15)
A)
the risk-free rate of interest on the dollar.
B)
the cost of capital in terms of dollars.
C)
the risk-free rate of interest on the yen.
D)
the cost of capital for the firm in terms of yen.
16)
Consider the following equation:
S ×CFC
(1 +r*
FC)
=F × CFC
(1 +r*
$)
The term F in this equation is
16)
A)
the future spot exchange rate.
B)
the current spot exchange rate.
C)
the forward exchange rate.
D)
the amount of foreign currency.
17)
Luther Industries, a U.S. firm, is considering an investment in Japan. The dollar cost of equity for
Luther is 12%. The risk-free interest rates on dollars and yen are r$= 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:
17)
A)
12.3%
B)
14.0%
C)
7.8%
D)
18.5%
18)
Which of the following statements regarding international projects is false?
18)
A)
Under internationally integrated capital markets, the value of an investment does not depend
on the currency we use in the analysis.
B)
The firm will probably face a different tax rate in the foreign country and will be subject to
both foreign and domestic tax codes.
C)
The project will most likely generate foreign currency cash flows, although the firm cares
about the foreign currency value of the project.
D)
Interest rates and costs of capital will likely be different in the foreign country as a result of
the macroeconomic environment.
Use the information for the question(s) below.
KT Enterprises, a U.S. import-export trading, is considering its international tax situation. Currently KT is 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
19)
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:
19)
A)
$20.5 million
B)
$5.1 million
C)
$35.6 million
D)
$29.5 million
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 rat on pounds, r£, is 4.80%.
20)
Using the covered interest parity condition, the calculated three-year forward rate F3 is closest to:
20)
A)
$1.8961/£
B)
$1.8568/£
C)
$1.8764/£
D)
$1.9161/£
Use the information for the question(s) below.
KT Enterprises, a U.S. import-export trading, is considering its international tax situation. Currently KT is U.S. tax rate is
35%. KT has significant operations in both Japan and Ireland. In Japan the current exchange rate is ¥118.4/$ 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
21)
The amount of the taxes paid in dollars for the Irish operations is closest to:
21)
A)
$50.0 million
B)
$20.5 million
C)
$5.1 million
D)
$29.5 million
22)
Consider the following equation:
r*
¥=1 +r¥
1 +r$(1 +r*
$) - 1
the term r*
$ in this equation refers to
22)
A)
the cost of capital for the firm in terms of yen.
B)
the risk-free rate of interest on the yen.
C)
the cost of capital in terms of dollars.
D)
the risk-free rate of interest on the dollar.
Use the information for the question(s) below.
KT Enterprises, a U.S. import-export trading, is considering its international tax situation. Currently KT is 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
23)
The amount of the taxes paid in dollars for the Japanese operations is closest to:
23)
A)
$20.5 million
B)
$29.5 million
C)
$50.0 million
D)
$5.1 million
24)
Which of the following statements is false?
24)
A)
When the foreign tax rates exceed the U.S. tax rates, there are no benefits to deferral because
in such a case there is no additional U.S. tax liability.
B)
The U.S. tax liability is not incurred until the profits are brought back home if the foreign
operation is set up as a foreign branch rather than as a separately incorporated subsidiary.
C)
When the foreign tax rate is less than the U.S. tax rate, deferral can provide significant
benefits.
D)
If a company chooses not to repatriate £12.5 million in pre-tax earnings, for example, it
effectively reinvests those earnings abroad and defers its U.S. tax liability.
25)
Which of the following statements is false?
25)
A)
In some countries, especially in the developing world, all investors do not have equal access
to financial securities.
B)
In some cases, a country's risk-free securities are internationally integrated but markets for a
specific firm's securities are not.
C)
Firms may face differential access to markets if there is any kind of asymmetry with respect to
information about them.
D)
When countries' capital markets are not integrated we call them disintegrated capital markets.
Use the information for the question(s) below.
KT Enterprises, a U.S. import-export trading, is considering its international tax situation. Currently KT is U.S. tax rate is
35%. KT has significant operations in both Japan and Ireland. In Japan the current exchange rate is ¥118.4/$ 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
26)
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:
26)
A)
$50.0 million
B)
$20.5 million
C)
$29.5 million
D)
$5.1 million
27)
Consider the following equation:
S ×CFC
(1 +r*
FC)
=F × CFC
(1 +r*
$)
The term r*
FC in this equation is
27)
A)
the appropriate cost of capital from the standpoint of a foreign investor.
B)
the risk-free rate for a foreign investor.
C)
the appropriate cost of capital from the standpoint of a U.S. investor.
D)
the risk-free rate for 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%.
28)
The present value of the £5 million cash inflow computed by first discounting the £s and then
converting into dollars is closest to:
28)
A)
$8,943,695
B)
$8,961,420
C)
$8,950,495
D)
$8,954,615
ESSAY. Write your answer in the space provided or on a separate sheet of paper.
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
110
214
318
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%.
29)
What is the dollar present value of the project?
30)
How do we make adjustments when a project has inputs and outputs in different currencies?
31)
What conditions cause the cash flows of a foreign project to be affected by exchange rate risk?
32)
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?
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
110
214
318
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%.
33)
Calculate the pound denominated cost of capital for Luther's project.
34)
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?
14
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
110
214
318
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%.
35)
What is the pound present value of the project?
15
Answer Key
Testname: C31
16
Answer Key
Testname: C31
17
