Banking Chapter 31 Homework International Corporate Finance You Are Investor Who Trying Calculate The Present

Chapter 31

International Corporate Finance

31–1. You are a U.S. investor who is trying to calculate the present value of a €14 million cash inflow

that will occur one year in the future. The spot exchange rate is S = $1.137/€ and the forward

rate is F1 = $1.159/€. You estimate that the appropriate dollar discount rate for this cash flow is

7% and the appropriate euro discount rate is 5%.

a. What is the present value of the €14 million cash inflow computed by first discounting the

euro and then converting it into dollars?

b. What is the present value of the €14 million cash inflow computed by first converting the

cash flow into dollars and then discounting?

c. What can you conclude about whether these markets are internationally integrated, based

on your answers to parts (a) and (b)?

31–2. Mia Caruso Enterprises, a U.S. manufacturer of children’s toys, has made a sale in Bulgaria and

is expecting a BGN17 million cash inflow in one year. The current spot rate is S = $0.5717/BGN

and the one-year forward rate is F1 = $0.5388/BGN.

a. What is the present value of Mia Caruso’s BGN17 million inflow computed by first

discounting the cash flow at the appropriate Bulgarian Lev discount rate of 6%, and then

converting the result into dollars?

b. What is the present value of the BGN17 million cash inflow computed by first converting the

cash flow into dollars and then discounting it at the appropriate dollar discount rate of

11%?

c. What can you conclude about whether these markets are internationally integrated, based

on your answers to parts (a) and (b)?

Chapter 31/International Corporate Finance 377

The new project has similar dollar risk to Manzetti’s other projects. The company knows that its

overall dollar WACC is 10.05%, so it feels comfortable using this WACC for the project. The

risk-free interest rate on dollars is 4.75% and the risk-free interest rate on euros is 6.95%.

a. Manzetti Foods is willing to assume that capital markets in the United States and the euro

area are internationally integrated. What is the company’s euro WACC?

b. What is the present value of the project in euros?

a. Using the formula for the Internationalization of the Cost of Capital, we have:

*

$$

11

++

rr

2 3 4

1.1236 1.1236 1.1236 1.1236

31–9. Tailor Johnson, a U.S. maker of fine menswear, has a subsidiary in Ethiopia. This year, the

subsidiary reported and repatriated earnings before interest and taxes (EBIT) of 100 million

Ethiopian birrs. The current exchange rate is 8 birr/$ or S1 = $0.125/birr. The Ethiopian tax rate

on this activity is 25%. U.S. tax law requires Tailor Johnson to pay taxes on the Ethiopian

earnings at the same rate as profits earned in the United States, which is currently 45%.

However, the United States gives a full tax credit for foreign taxes paid up to the amount of the

U.S. tax liability. What is Tailor Johnson’s U.S. tax liability on its Ethiopian subsidiary?

31-10. Tailor Johnson, the menswear company with a subsidiary in Ethiopia described in Problem 9, is

considering the tax benefits resulting from deferring repatriation of the earnings from the

subsidiary. Under U.S. tax law, the U.S. tax liability is not incurred until the profits are brought

back home. Tailor Johnson reasonably expects to defer repatriation for 10 years, at which point

the birr earnings will be converted into dollars at the prevailing spot rate, S10, and the tax credit

for Ethiopian taxes paid will still be converted at the exchange rate S1 = $0.125/birr. Tailor

Johnson’s after-tax cost of debt is 5%.

a. Suppose the exchange rate in 10 years is identical to this year’s exchange rate, so S10 =

$0.125/birr. What is the present value of deferring the U.S. tax liability on Tailor Johnson’s

Ethiopian earnings for 10 years?

b. How will the exchange rate in 10 years affect the actual amount of the U.S. tax liability?

Write an equation for the U.S. tax liability as a function of the exchange rate S10.

378 Berk/DeMarzo, Corporate Finance, Fourth Edition, Global Edition

a. From question 31-9, the tax liability is $2.5 million. Deferred for 10 years, using the after-tax cost

of debt at 5%, the present value is

10

2.5/1.05 $1.53=

million. Hence, the value of deferral is 2.5 –

1.53 = $0.97 million.

b. The earnings will need to be converted at the future exchange rate,

10

S

, although the tax credit

will still be calculated at

1$0.125/S birr=

. Hence, the U.S. tax liability will be

10

(0.45)( )(100) 3.125S−

.

31-11. Peripatetic Enterprises, a U.S. import-export trading firm, is considering its international tax

situation. U.S. tax law requires U.S. corporations to pay taxes on their foreign earnings at the

same rate as profits earned in the United States; this rate is currently 45%. However, a full tax

credit is given for the foreign taxes paid up to the amount of the U.S. tax liability. Peripatetic has

major operations in Poland, where the tax rate is 20%, and in Sweden, where the tax rate is

60%. The profits, which are fully and immediately repatriated, and foreign taxes paid for the

current year are shown here:

a. What is the U.S. tax liability on the earnings from the Polish subsidiary assuming the

Swedish subsidiary did not exist?

b. What is the U.S. tax liability on the earnings from the Swedish subsidiary assuming the

Polish subsidiary did not exist?

c. Under U.S. tax law, Peripatetic is able to pool the earnings from its operations in Poland and

Sweden when computing its U.S. tax liability on foreign earnings. Total EBIT is thus $179.1

million and the total host country taxes paid is $77.2 million. What is the total U.S. tax

liability on foreign earnings? Show how this relates to the answers in parts (a) and (b).

31-12. Suppose the interest on Russian government bonds is 7.9%, and the current exchange rate is 28.6

rubles per dollar. If the forward exchange rate is 29.1 rubles per dollar, and the current U.S.

risk-free interest rate is 4.8%, what is the implied credit spread for Russian government bonds?

$

1

+



i

Chapter 31/International Corporate Finance 379

where

R

r

and

$

r

are risk-free interest rates in rubles and dollars respectively. With this equation we

can use the spot and forward exchange rates, and the risk-free $ interest rate, to solve for the risk–free

ruble interest rate:

$

29.1

(1 ) 1 (1.048) 1 6.632%

28.6

= + − = − =

R

F

rr

S

Therefore, the implied risk-free ruble interest rate is 6.632%, implying that Russian government bonds

have an implied credit spread of 7.9% – 6.632% = 1.1268% to compensate investors for the possibility

of the Russian government defaulting.

31-13. Assume that in the original Ityesi example in Table 31.1, all sales actually occur in the United

States and are projected to be $60 million per year for four years. Keeping other costs the same,

calculate the NPV of the investment opportunity.

The solution to this problem is in the following Excel spreadsheet:

0 1 2 3 4

Sales in UK 0 0 0 0

Cost of Sales -15.625 -15.625 -15.625 -15.625

Gross Profit -15.625 -15.625 -15.625 -15.625

Operating Expenses -4.167 -5.625 -5.625 -5.625 -5.625

Depreciation -3.75 -3.75 -3.75 -3.75

EBIT -4.167 -25 -25 -25 -25

Less: Taxes 1.667 -5 -5 -5 -5

Plus: Depreciation 3.75 3.75 3.75 3.75

Less: Capital Expenditures -15

FCF (£ millions) -17.500 -26.250 -26.250 -26.250 -26.250

Forward Exchange Rate 1.6000 1.5551 1.5115 1.4692 1.4280

FCF ($ millions) -28.000 -40.822 -39.678 -38.565 -37.484

Sales in the US 60 60 60 60

CF ($ millions) -28.000 19.178 20.322 21.435 22.516