Solutions to Problems
P19-1. Note to instructors: This problem was dramatically changed in the print run after the Tax Cuts and Jobs
Act became effective. The original question, answered below, focused on tax issues that applied before
the new tax law was passed. The revised question, also answered below, had an entirely different focus
on exchange rate movements.
Tax credits
LG 1; Intermediate
MNC’s receipt of dividends can be calculated as follows:
Subsidiary income before local taxes $250,000
a. If tax credits are allowed, then the so-called “grossing up” procedure will be applied:
Additional MNC income $250,000
b. If no tax credits are permitted, then:
MNC’s receipt of dividends $152,425
Revised P19-1
a. If the basket of goods costs $153 in New York, then the exchange rate that makes the basket cost the
b. If inflation in the United States is 6%, then the same basket of goods will cost 6% more or $162.18.
If inflation in France is 2%, then the same basket of goods will cost 2% more or 135.66 euros. The
P19-2. Translation of financial statements
LG 3; Intermediate
Balance Sheet
12/31/19 12/31/20
U.S.$ U.S.$*
Cash 48.00 50.88
Inventory 360.00 381.60
Plant and equipment (net) 192.00 203.52
Partial income statement
12/31/19 12/31/20
U.S.$ U.S.$
Sales 36,000.00 38,160.00
*At 6% appreciation, the new exchange rate becomes U.S.$ 1.272 /€
**Differences in totals result from rounding.
P19-3. Personal finance problem: Exchange rates
LG 3; Easy
a. Cost of tour (EUR)
Current exchange rate
$ 2,750
1.3411
b. Amount of euros needed in Italy
Cost of means in Italy (EUR)
Miscellaneous expenditures
500
$ 1,000
P19-4. Personal finance: International investment diversification
LG 4; Intermediate
b. (1
)Global funds are the most diverse of the four categories. But don’t be fooled by their
cosmopolitan-sounding name. They’re able to be invested in any region of the world,
including the United States, so they don’t actually offer as much diversification as a
(2
)International funds invest most of their assets outside the United States. Depending
on the countries selected for investment, international funds can range from relatively
safe to more risky. Vanguard’s International Growth Fund (VWIGX), for instance,
extensive exposure to companies in communist countries, such as T. Rowe Price’s
Emerging Markets Stock Fund, which has a plurality of its portfolio in Chinese
(3
)Emerging-market funds are the most volatile. They invest in undeveloped regions of
the world, which have enormous growth potential but also pose significant risks—
(4
)Country-specific funds are invested in one country or region of the world. That kind
of concentration makes them particularly volatile. If you pick the right country—
P19-5. Euromarket investment and fund raising
LG 5; Challenge
The effective rates of interest can be obtained by adjusting the nominal rates by the forecast percent
revaluation in each case:
US$ MP ¥
Effective rates
Euromarket 4.00% 3.01% 3.53%
Following the assumption outlined in the problem, the best sources of investment and borrowing are the
following:
P19-6. Ethics problem
LG 1; Intermediate
Yes, because the company may lose out in numerous contract bid opportunities. The management team
must explain that it is “ethics first” when doing business, and that the objective is to maximize
Case
Case studies are available on www.myfinancelab.com.
Assessing a Direct Investment in Chile by U.S. Computer Corporation
In this case, students evaluate the feasibility of a proposed foreign investmentconstruction of a factory in
Chile. They must consider many factors that make international transactions complex, including political and
foreign exchange rate risks and raising funds in international markets.
a. Cost of capital—US$:
Type of Capital Amount Weight Cost Weighted
Cost
Long-term debt 6,000,000 60.00% 6.0% 3.60%
b. Present value (PV), 5 years:
Operating cash
flow
sales 0.20
$20,000,000 0.20
If the dollar appreciates (gets stronger) against the Chilean peso, it takes more pesos to buy each dollar. For
example, if the exchange rate changes to 800 pesos per dollar, sales of Ps 14 billion equals $17,500,000,
c. USCC faces foreign exchange risks because the value of the Chilean peso can fluctuate against the dollar,
and it is not a currency that can be hedged. Any changes in exchange rates will result in a corresponding
Chile with sales denominated in dollars.
d. Local (peso) financing carries a much higher cost, 14% for long-term funds versus 6% in the Eurobond
market. Also, if the peso depreciates against the dollar, the value of USCC’s investment will decrease, as
Joining into a bilateral trade pact would strengthen Chile’s economic ties with the United States. This
should make the project more attractive.
Spreadsheet Exercise
The answer to Chapter 19’s MNC economic exposure spreadsheet problem is available on
www.pearson.com/mylab/finance.
Group Exercise
Group exercises are available on www.myfinancelab.com.
This final chapter broadens the view of the firm internationally. This is also the direction of this final
assignment. Opportunities for expansion are now investigated beyond the fictitious firm’s domestic borders. This
Exchange rate risk is the next part of the assignment. This begins by first retrieving recent exchange rate
information for the national currency of choice. This recent information is then compared to the past five years
to give students a sense of volatility in the exchange rate. Risk analysis is then enhanced by comparing the U.S.
Integrative Case 8: Organic Solutions
Integrative Case 8, Organic Solutions, asks students to evaluate a proposed acquisition by means of either a cash
transaction or a stock swap. The effects on the short- and long-term earnings per share (EPS) should be
calculated and other proposals to achieve the merger discussed. The students must also consider the qualitative
implications of acquiring a non-U.S.-based company.
a. Price for cash acquisition of GTI:
Yea
r
Incremental
Cash Flow Discount Rate Present Value
of GTI
1 $18,750,000 16% $139,243,245
2 18,750,000
The maximum price Organic Solutions (OS) should offer GTI for a cash acquisition is $139,243,245. Net
b. 1. Straight bonds—Financing such a large portion of the acquisition with straight bonds will
dramatically increase the financial risk of the firm. The management of OS must be very comfortable
that the combined firm is able to generate adequate cash to service this debt. The coupon rate on these
2. Convertible bonds—Initially, convertibles will provide much of the same concern as straight bonds
because financial leverage will increase. There are two benefits to convertible bonds not available with
straight bonds. First is that the coupon rate will be lower. Investors will value the conversion feature
3. Bonds with stock purchase warrants attached—The benefits and disadvantages of this security mix are
similar to those of a convertible bond. However, there is one major difference. The attached warrants
c. 1. Ratio of exchange: $30 $50 0.60
2. The exchange of stock should increase OS’s EPS to $3.93, an increase from $3.50.
Calculations:
New OS shares required: 4,620,000 0.60 2,772,000
The decrease in EPS for GTI can be explained by looking at the price/earnings (P/E) ratio for OS and
the P/E ratio based on the price paid for GTI:
OS GTI
Price per share $50 $30
(market) (price
paid)
When the P/E ratio paid is less than the P/E ratio of the acquiring company, there is an increase in the
acquiring company’s EPS and a decrease in the target’s EPS.
3. Over the long run, the EPS of the merged firm would probably not increase. Usually the earnings
d. OS could make a tender offer to GTI’s stockholders or the firm could propose a combination cash payment-
stock swap acquisition.
e. The fact that GTI is actually a foreign-based company would impact many areas of the foregoing analysis.
Regulations that apply to international operations tend to complicate the preparation of financial statements
for foreign-based subsidiaries. Certain factors influence the risk and return characteristics of a MNC,
