Chapter 18
Financing in the Long-Term
Lecture Outline
Financing to Match the Inflow Currency
Using Currency Swaps to Execute the Matching Strategy
Using Parallel Loans to Execute the Matching Strategy
Debt Denomination Decision by Subsidiaries
Debt Maturity Decision
Assessment of Yield Curve
Financing Costs of Loans with Different Maturities
Fixed Versus Floating Debt Decision
2 Financing in the Long-Term
Chapter Theme
Should the MNC choose bonds as a medium to attract long-term funds, a currency for denomination
must be chosen. This is a critical decision for the MNC. While there is no clear-cut solution, this
Topics to Stimulate Class Discussion
1. Why would U.S. firms consider issuing bonds denominated in a foreign currency?
POINT/COUNTER-POINT:
Will Currency Swaps Result in Low Financing Costs?
POINT: Yes. Currency swaps have created greater participation by firms that need to exchange their
COUNTER-POINT: No. Currency swaps will establish an exchange rate that is based on market forces.
If a forward rate exists for a future period, the swap rate should be somewhat similar to the forward rate.
WHO IS CORRECT? Use the Internet to learn more about this issue. Which argument do you support?
Offer your own opinion on this issue.
Answers to End of Chapter Questions
1. Floating-Rate Bonds.
a. What factors should be considered by a U.S. firm that plans to issue a floating rate bond
denominated in a foreign currency?
ANSWER: A U.S. firm should consider the interest rate for each possible currency as well as
Financing in the Long-Term 3
b. Is the risk of issuing a floating rate bond higher or lower than the risk of issuing a fixed rate
Eurobond? Explain.
ANSWER: The risk from issuing a floating rate bond is that the interest rate may rise over time.
c. How would an investing firm differ from a borrowing firm in the features (i.e., interest rate and
currency’s future exchange rates) it would prefer a floating rate foreign currency-denominated
bond to exhibit?
ANSWER: An investing firm prefers a bond denominated in a currency that is expected to
2. Risk From Issuing Foreign Currency-Denominated Bonds. What is the advantage of using
simulation to assess the bond financing position?
ANSWER: Unlike point forecasts, simulation provides a distribution of possible outcomes. Thus,
3. Exchange Rate Effects.
a. Explain the difference in the cost of financing with foreign currencies during a strong-dollar
period, versus a weak-dollar period for a U.S. firm.
b. Explain how a U.S.-based MNC issuing bonds denominated in euros may be able to offset a
portion of its exchange rate risk.
4. Bond Offering Decision. Columbia Corp. is a U.S. company with no foreign currency cash flows. It
plans to either issue a bond denominated in euros with a fixed interest rate, or a bond denominated in
U.S. dollars with a floating interest rate. It estimates its periodic dollar cash flows for each bond.
Which bond do you think would have greater uncertainty surrounding these future dollar cash flows?
Explain.
4 Financing in the Long-Term
ANSWER: Exchange rates are generally more volatile than interest rates over time. Therefore the
5. Borrowing Combined with Forward Hedging. Cedar Falls Co. has a subsidiary in Brazil, where
local interest rates are high. It considers borrowing dollars and hedging the exchange rate risk by
selling the Brazilian real forward in exchange for dollars for the periods in which it would need to
make loan payments in dollars. Assume that forward contracts on the real are available. What is the
limitation of this strategy? ?
ANSWER: Because of interest rate parity, the forward rate of the real will contain a discount to
6. Financing That Reduces Exchange Rate Risk. Kerr, Inc., a major U.S. exporter of products to
Japan, denominates its exports in dollars and has no other international business. It can borrow
dollars at 9 percent to finance its operations or borrow yen at 3 percent. If it borrows yen, it will be
exposed to exchange rate risk. How can Kerr borrow yen and possibly reduce its economic exposure
to exchange rate risk?
ANSWER: Kerr could invoice its exports in yen and use the proceeds to pay back loans. Its
7. Exchange Rate Effects. Katina, Inc., is a U.S. firm that plans to finance with bonds denominated in
euros to obtain a lower interest rate than is available on dollar-denominated bonds. What is the most
critical point in time when the exchange rate will have the greatest impact?
8. Financing Decision. Ivax Corp. (based in Miami) is a U.S. drug company that has attempted to
capitalize on new opportunities to expand in Eastern Europe. The production costs in most Eastern
European countries are very low, often less than one-fourth of the cost in Germany or Switzerland.
Furthermore, there is a strong demand for drugs in Eastern Europe. Ivax penetrated Eastern Europe
by purchasing a 60 percent stake in Galena AS, a Czech firm that produces drugs.
a. Should Ivax finance its investment in the Czech firm by borrowing dollars from a U.S. bank that
would then be converted into koruna (the Czech currency) or by borrowing koruna from a local
Czech bank? What information do you need to know to answer this question?
ANSWER: Ivax would need to consider the interest rate in the U.S. versus the interest rate when
Financing in the Long-Term 5
b. How can borrowing koruna locally from a Czech bank reduce the exposure of Ivax to exchange
rate risk?
ANSWER: By borrowing koruna, the Czech subsidiary of Ivax should make its interest payments
c. How can borrowing koruna locally from a Czech bank reduce the exposure of Ivax to political
risk caused by government regulations?
ANSWER: By borrowing from a local Czech bank, Ivax may be able to avoid excessive regulations
Advanced Questions
9. Bond Financing Analysis. Sambuka, Inc. can issue bonds in either U.S. dollars or in Swiss francs.
Dollar-denominated bonds would have a coupon rate of 15 percent; Swiss franc-denominated bonds
would have a coupon rate of 12 percent. Assuming that Sambuka can issue bonds worth $10,000,000
in either currency, that the current exchange rate of the Swiss franc is $.70, and that the forecasted
exchange rate of the franc in each of the next three years is $.75, what is the annual cost of financing
for the franc-denominated bonds? Which type of bond should Sambuka issue?
ANSWER:
If Sambuka issues Swiss franc-denominated bonds, the bonds would have a face value of
10. Bond Financing Analysis. Hawaii Co. just agreed to a long-term deal in which it will export
products to Japan. It needs funds to finance the production of the products that it will export. The
products will be denominated in dollars. The prevailing U.S. long-term interest rate is 9 percent
6 Financing in the Long-Term
versus 3 percent in Japan. Assume that interest rate parity exists, and that Hawaii Co. believes that
the international Fisher effect holds.
a. Should Hawaii Co. finance its production with yen and leave itself open to the exchange rate
risk? Explain.
b. Should Hawaii Co. finance its production with yen and simultaneously engage in forward
contracts to hedge its exposure to exchange rate risk?
c. How could Hawaii Co. achieve low-cost financing while eliminating its exposure to exchange
rate risk?
ANSWER: Hawaii could request that the Japanese importers pay for their imports in yen. It could
11. Cost of Financing. Assume that Seminole, Inc., considers issuing a Singapore dollar-denominated
bond at its present coupon rate of 7 percent, even though it has no incoming cash flows to cover the
bond payments. It is attracted to the low financing rate, since U. S. dollar-denominated bonds issued
in the United States would have a coupon rate of 12 percent. Assume that either type of bond would
have a four-year maturity and could be issued at par value. Seminole needs to borrow $10 million.
Therefore, it will either issue U. S. dollar denominated bonds with a par value of $10 million or
bonds denominated in Singapore dollars with a par value of S$20 million. The spot rate of the
Singapore dollar is $.50. Seminole has forecasted the Singapore dollar’s value at the end of each of
the next four years, when coupon payments are to be paid:
End of Year Exchange Rate of Singapore Dollar
1 $.52
2 .56
3 .58
4 .53
Determine the expected annual cost of financing with Singapore dollars. Should Seminole, Inc.,
issue bonds denominated in U.S. dollars or Singapore dollars? Explain.
ANSWER:
End of Year:
1
2
3
4
Financing in the Long-Term 7
12. Interaction Between Financing and Invoicing Policies. Assume that Hurricane, Inc., is a U.S.
company that exports products to the U.K., invoiced in dollars. It also exports products to Denmark,
invoiced in dollars. It currently has no cash outflows in foreign currencies, and it plans to issue
bonds in the near future. Hurricane could likely issue bonds at par value in (1) dollars with a coupon
rate of 12 percent, (2) Danish kroner with a coupon rate of 9 percent, or (3) pounds with a coupon
rate of 15 percent. It expects the kroner and pound to strengthen over time. How could Hurricane
revise its invoicing policy and make its bond denomination decision to achieve low financing costs
without excessive exposure to exchange rate fluctuations?
ANSWER: Hurricane could invoice goods exported to Denmark in kroner instead of dollars. Thus,
13. Swap Agreement. Grant, Inc., is a well-known U.S. firm that needs to borrow 10 million British
pounds to support a new business in the United Kingdom. However, it cannot obtain financing from
British banks because it is not yet established within the United Kingdom. It decides to issue dollar–
denominated debt (at par value) in the U.S., for which it will pay an annual coupon rate of 10%. It
then will convert the dollar proceeds from the debt issue into British pounds at the prevailing spot
rate (the prevailing spot rate is one pound = $1.70). Over each of the next three years, it plans to use
the revenue in pounds from the new business in the United Kingdom to make its annual debt
payment. Grant, Inc., engages in a currency swap in which it will convert pounds to dollars at an
exchange rate of $1.70 per pound at the end of each of the next three years. How many dollars must
be borrowed initially to support the new business in the United Kingdom? How many pounds should
Grant, Inc., specify in the swap agreement that it will swap over each of the next three years in
exchange for dollars so that it can make its annual coupon payments to the U.S. creditors?
ANSWER: Since Grant Inc. needs 10 million pounds, Grant will need to issue debt amounting to
14. Interest Rate Swap. Janutis Co. has just issued fixed rate debt at 10 percent. Yet, it prefers to
convert its financing to incur a floating rate on its debt. It engages in an interest rate swap in which it
swaps variable rate payments of LIBOR plus 1% in exchange for payments of 10%. The interest
rates are applied to an amount that represents the principal from its recent debt issue in order to
determine the interest payments due at the end of each year for the next three years. Janutis Co.
8 Financing in the Long-Term
expects that the LIBOR will be 9% at the end of the first year, 8.5% at the end of the second year,
and 7% at the end of the third year. Determine the financing rate that Janutis Co. expects to pay on
its debt after considering the effect of the interest rate swap.
ANSWER: The fixed rate of 10% to be received from the interest rate swap offsets the 10%
15. Financing and the Currency Swap Decision. Bradenton Co. is considering a project in which it
will export special contact lenses to Mexico. It expects that it will receive 1 million pesos after taxes at
the end of each year for the next 4 years, and after that time its business in Mexico will end as its special
patent will be terminated. The peso’s spot rate is presently $.20. The U.S. annual risk-free interest rate is
6% while Mexico’s annual risk-free interest rate is 11%. Interest rate parity exists. Bradenton Co. uses
the one-year forward rate as a predictor of the exchange rate in one year. Bradenton Co. also presumes
that the exchange rates in each of the years 2 through 4 will also change by the same percentage as it
predicts for year 1. Bradenton searches for a firm with which it can swap pesos for dollars over each of
the next 4 years. Briggs Co. is an importer of Mexican products. It is willing to take the 1 million pesos
per year from Bradenton Co. and will provide Bradenton Co. with dollars at an exchange rate of $.17 per
peso. Ignore tax effects.
Bradenton Co. has a capital structure of 60% debt and 40% equity. Its corporate tax rate is 30%. It
borrows funds from a bank and pays 10% interest on its debt. It expects that the U.S. annual stock
market return will be 18% per year. Its beta is .9. Bradenton would use its cost of capital as the
required return for this project.
a. Determine whether the NPV of this project if Bradenton engages in the currency swap.
b. Determine the NPV of this project if Bradenton does not hedge the future cash flows.
ANSWER:
Financing in the Long-Term 9
Bradenton’s cost of equity is:
a) No hedge
Year 1
Year 2
Year 3
Year 4
After tax profit
in MXP
MXP1,000,000
MXP1,000,000
MXP1,000,000
MXP1,000,000
Exchange Rate
Cash Flow
to parent
b) Swap
Year 1
Year 2
Year 3
Year 4
After tax profit
in MXP
MXP1,000,000
MXP1,000,000
MXP1,000,000
MXP1,000,000
Exchange Rate
Cash Flow to
parent
PV (discount
rate of 10.92%)
NPV
16. Financing and Exchange Rate Risk. The parent of Nester Co. (a U.S. firm) has no international
business but plans to invest $20 million in a business in Switzerland. Since the operating costs of this
business are very low, Nester Co. expects this business to generate much cash flows in Swiss francs
that will be remitted to the parent each year.
Nester will finance half of this project with debt. It has these choices for financing the project:
* obtain half of the funds needed from parent equity and the other half by borrowing dollars
* obtain half of the funds needed from parent equity and the other half by borrowing Swiss francs
* obtain half of the funds that are needed from parent equity and obtain the remainder by borrowing
an equal amount of dollars and Swiss francs
The interest rate on dollars is the same as the interest rate on Swiss francs.
10 Financing in the Long-Term
a. Which choice will result in the most exchange rate exposure?
b. Which choice will result in the least exchange rate exposure?
c. If the Swiss franc was expected to appreciate over time, which financing choice would result in the
highest expected net present value?
ANSWER:
17. Financing and Exchange Rate Risk. Vix Co. (of the U.S.) presently serves as a distributor of
products by purchasing them from other U.S. firms and selling them in Europe. It wants to purchase a
manufacturer in Thailand that could produce similar products at a low cost (due to low labor costs in
Thailand) and export the products to Europe. The operating expenses would be denominated in Thai
currency (the baht). The products would be invoiced in euros. If Vix Co. can acquire a manufacturer,
it will discontinue its existing distributor business. If Vix Co. purchases a company in Thailand, it
expects that its revenue might not be sufficient to cover its operating expenses during the first 8
years. It will need to borrow funds for an 8-year term to ensure that it has enough funds to pay all of
its operating expenses in Thailand. It can borrow funds denominated in U.S. dollars, in Thai baht, or
in euros. Assuming that its financing decision will be primarily intended to minimize its exposure to
exchange rate risk, which currency should it borrow? Briefly explain.
18. Financing and Exchange Rate Risk. Compton Co. has a subsidiary in Thailand that produces
computer components. The subsidiary sells the components to manufacturers in the U.S. The
components are invoiced in U.S. dollars. Compton pays employees of the subsidiary in Thai baht and
makes a large monthly lease payment in Thai baht. Compton financed the investment in the Thai
subsidiary by borrowing dollars borrowed from a U.S. bank. Compton has no other international
business.
a. Given the conditions, is Compton affected favorably or unfavorably, or not affected by
depreciation of the Thai baht? Briefly explain.
b. Assume that interest rates in Thailand declined recently, so Compton subsidiary considers
obtaining a new loan in Thai baht. Compton would use the proceeds to pay off its existing loan from
a U.S. bank. Will this form of financing increase, reduce, or have no impact on its economic
exposure to exchange rate movements? Briefly explain.
ANSWER
a. Compton Co. is favorably affected by depreciation of the baht. All revenues are in dollars. When
Financing in the Long-Term 11
19. Selecting a Loan Maturity. Omaha Co. has a subsidiary in Chile that wants to borrow from a
local bank at a fixed rate over the next 10 years.
a. Explain why Chile’s term structure of interest rates (as reflected in its yield curve) might cause the
subsidiary to borrow for a different term to maturity.
b. If Omaha is offered a more favorable interest rate for a term of 6 years, explain the potential
disadvantage compared to a 10-year loan.
c. Explain how the subsidiary can determine whether to select the 6-year loan versus the 10-year
loan.
ANSWER
20. Project Financing. Dryden Co. is a U.S. firm that plans a foreign project in which it needs
$8,000,000 as an initial investment. The project is expected to generate cash flows of 10 million
euros in one year, after the complete repayment of the loan (including the loan interest and principal).
The project has zero salvage value and is terminated at the end of one year. Dryden considers
financing this project with:
*all U.S. equity,
*all U.S. debt (loans) denominated in dollars provided by U.S. banks,
*all debt (loans) denominated in euros provided by European banks, or
*half of funds obtained from loans denominated in euros, and half obtained from loans denominated in
dollars.
Which form of financing will cause the project’s NPV to be the least sensitive to exchange rate risk?
ANSWER: The financing with euro-denominated loans creates cash outflow in euros that offsets a
12 Financing in the Long-Term
Solution to Continuing Case Problem: Blades, Inc.
1. Given that Blades expects to use the cash flows generated by the Thai subsidiary to pay the interest
and principal of the notes, would the effective financing cost of the baht-denominated notes be
affected by exchange rate movements? Would the effective financing cost of the yen-denominated
notes be affected by exchange rate movements? How?
ANSWER: No, the effective financing cost of the baht-denominated notes would not be affected by
2. Construct a spreadsheet to determine the annual effective financing percentage cost of the yen–
denominated notes issued in each of the three scenarios for the future value of the yen. What is the
probability that the financing cost of issuing yen-denominated notes is lower than the cost of issuing
baht-denominated notes?
ANSWER: (See spreadsheet below.) The annual effective financing percentage costs for the three
Calculation of Interest Expense:
Annual Interest Expense of Yen-Denominated Notes
(1,250,000,000 × 10%)
125,000,000
(1) Yen Value Changes
by 0 Percent Annually
Relative to the Baht
End of
Year:
Annual Cost
1
2
3
4
5
of Financing
Payments in Japanese Yen
125,000,000
125,000,000
125,000,000
of Japanese Yen in Baht
Payments in Baht
Financing in the Long-Term 13
(2) Yen Value Changes
by 2 Percent
Annually Relative
to the Baht
End of
Year:
Annual Cost
1
2
3
4
5
of Financing
(3) Yen Value Changes
by 3 Percent Annually
Relative to the Baht
End of
Year:
1
2
3
4
5
3. Using a spreadsheet, determine the expected annual effective financing percentage cost of issuing
yen-denominated notes. How does this expected financing cost compare with the expected financing
cost of the baht-denominated notes?
ANSWER: (See spreadsheet below.) The expected annual effective financing cost of issuing yen–
(1)
(2)
(3) = (1) × (2)
Exchange Rate Scenario
Effective Financing
Percentage Cost
Probability
Product
Scenario 1: No Change in Yen Value
2.00%
Scenario 2: Annual Appreciation of Yen by
2 Percent
6.10%
Scenario 3: Annual Appreciation of Yen by
3 Percent
3.99%
12.09%
4. Based on your answers to the previous questions, do you think Blades should issue yen- or baht-
denominated notes?
14 Financing in the Long-Term
5. What is the tradeoff involved?
ANSWER: The cost of financing in baht is known with certainty, because Blades could use baht–
Solution to Supplemental Case: Devil VCR Corporation
a. It can reduce its exposure to exchange rate risk, because it could convert the proceeds of the bond
into pounds to cover future production expenses and could use a portion of the revenue in
Singapore dollars each year to pay its coupon payments to bondholders.
because it is not offsetting the revenue received in Singapore dollars.
Small Business Dilemma
Long-Term Financing Decision by the Sports Exports Company
The Sports Exports Company continues to focus on producing footballs in the U.S. and exporting them to
the United Kingdom. The exports are denominated in pounds, which has continually exposed the firm to
exchange rate risk. It is now considering a new form of expansion where it would sell specialty sporting
goods in the U.S. If it pursues this U.S. project, it would need to borrow long-term funds. The dollar-
denominated debt has an interest rate that is slightly lower than the pound-denominated debt.
1. Jim Logan, owner of the Sports Exports Company, needs to determine whether dollar-denominated
debt or pound-denominated debt would be most appropriate for financing this expansion, if he does
expand. He is leaning toward financing the U.S. project with dollar-denominated debt, since his goal
is to avoid exchange rate risk. Is there any reason why he should consider using pound-denominated
debt to reduce exchange rate risk?
ANSWER: Yes. Jim’s existing export business results in pound receivables. He could use some of
2. Assume that Jim decides to finance his proposed U.S. business with dollar-denominated debt if he
does implement the U.S. business idea. How could he use a currency swap along with the debt to
reduce the firm’s exposure to exchange rate risk?
Financing in the Long-Term 15
ANSWER: The Sports Exports Company could borrow long-term funds denominated in dollars to
Part 4 — Integrative Problem
Long-Term Asset and Liability Management
Gandor Company is a U.S. firm that is considering a joint venture with a Chinese firm to produce and
sell DVDs. Gandor will invest $12 million in this project, which will help to finance the Chinese firm’s
production. For each of the first three years, 50 percent of the total profits will be distributed to the
The expected total profits resulting from the joint venture per year are as follows:
Year
Total Profits from Joint
Venture (in yuan, CHY)
Gandor’s average cost of debt is 13.8 percent before taxes. Its average cost of equity is 18 percent.
Assume that the corporate income tax rate imposed on Gandor is normally 30 percent. Gandor uses a
capital structure composed of 60 percent debt and 40 percent equity. Gandor automatically adds 4
percentage points to its cost of capital when deriving its required rate of return on international joint
ventures. Though this project has particular forms of country risk that are unique, Gandor plans to
account for these forms of risk within its estimation of cash flows.
16 Financing in the Long-Term
1. Determine Gandor’s cost of capital. Also, determine Gandor’s required rate of return for the joint
venture in China.
ANSWER: Gandor’s weighted average cost of capital is:
2. Determine the probability distribution of Gandor’s net present values for the joint venture.
Capital budgeting analyses should be conducted for these scenarios:
Scenario 1 Based on original assumptions.
Scenario 2 Based on an increase in the corporate income tax by the Chinese government.
Scenario 3 Based on the imposition of a withholding tax by the Chinese government.
SCENARIO 1: BASED ON ORIGINAL ASSUMPTIONS
(Probability = 60%)
Year 0
Year 1
Year 2
Year 3
Total profits
(in CHY)
CHY60,000,000
CHY80,000,000
CHY100,000,000
Gandor Co.
(50% of total)
CHY30,000,000
CHY40,000,000
CHY150,000,000
Financing in the Long-Term 17
Corporate income taxes
imposed by Chinese
government (20%)
CHY6,000,000
CHY8,000,000
CHY10,000,000
Profits to Gandor after
paying corporate
income taxes in China
CHY24,000,000
CHY32,000,000
CHY40,000,000
received from China
(based on exchange rate
of CHY1 = $.20)
U.S. taxes paid (10%)
$480,000
$640,000
Cash flows from joint
venture
a 17% discount rate)
Initial investment
$12,000,000
Cumulative NPV of
cash flows
–$8,307,692
–$4,099,934
$395,534
SCENARIO 2: BASED ON INCREASE IN CORPORATE INCOME TAX BY CHINESE GOVERNMENT
(Probability = 20%)
Year 0
Year 1
Year 2
Year 3
Total profits
(in CHY)
CHY60,000,000
CHY80,000,000
CHY100,000,000
Profits allocated
to Gandor Co.
(50% of total)
government
(40%)
CHY12,000,000
CHY16,000,000
CHY20,000,000
18 Financing in the Long-Term
Profits to Gandor
after paying
corporate income
taxes in China
CHY18,000,000
CHY24,000,000
CHY30,000,000
on exchange rate
of CHY1 = $.20)
$3,600,000
$4,800,000
$6,000,000
U.S. taxes paid
(0%)
Cash flows from
joint venture
$3,600,000
$4,800,000
$6,000,000
PV of cash flows
(using a 17%
discount rate)
$3,076,923
$3,506,465
$3,746,223
Initial investment
$12,000,000
Cumulative NPV
of cash flows
–$8,923,077
–$5,416,612
–$1,670,389
SCENARIO 3: IMPOSITION OF A WITHHOLDING TAX BY CHINESE GOVERNMENT
(Probability = 20%)
Year 0
Year 1
Year 2
Year 3
Total profits
(in CHY)
CHY60,000,000
CHY80,000,000
CHY100,000,000
Profits allocated to
Gandor Co.
(50% of total)
CHY30,000,000
CHY40,000,000
CHY50,000,000
Corporate income
taxes imposed by
Chinese
government (20%)
CHY10,000,000
Financing in the Long-Term 19
Profits to Gandor
after paying
corporate income
taxes in China
CHY24,000,000
CHY32,000,000
CHY40,000,000
Withholding tax
(10%)
Profits to be sent to
the U.S.
CHY21,600,000
CHY28,800,000
CHY36,000,000
profits received
from China (based
on exchange rate of
CHY1 = $.20)
$4,320,000
$5,760,000
$7,200,000
U.S. taxes paid
(10%)
$7,200,000
Cash flows from
joint venture
$3,888,000
$5,184,000
$6,480,000
PV of cash flows
(using a 17%
discount rate)
$3,323,077
$3,786,982
$4,045,921
Initial investment
Cumulative NPV of
cash flows
20 Financing in the Long-Term
SUMMARY OF SCENARIOS
Scenario
NPV for This Scenario
Probability that This
Scenario Will Occur
Original scenario
$395,534
60%
by Chinese government
20%
by Chinese government
20%
Increase in corporate income tax
3. Would you recommend that Gandor participate in the joint venture? Explain.
ANSWER: The expected value of the NPV is negative. In addition, there is a 40 percent chance that
4. What do you think would be the key underlying factor that would have the most influence on the
profits earned in China as a result of the joint venture?
5. Is there any reason for Gandor to revise the composition of its capital (debt and equity) obtained from
the U.S. when financing joint ventures like this?
ANSWER: Gandor may consider using more equity if it believes that the cash flows from joint
its debt.
6. When Gandor was assessing this proposed joint venture, some of its managers of recommended that
Gandor borrow the Chinese currency rather than dollars to obtain some of the necessary capital for
its initial investment. They suggested that such a strategy could reduce Gandor’s exchange rate risk.
Do you agree? Explain.
ANSWER: In this case, the exchange rate is guaranteed by the government, so the concept of