8. Nominal versus effective cost of debt (intermediate). Black & Decker, a U.S.

multinational manufacturer of small power tools, is considering financing a plant expansion in France with euro (€) Eurobonds. The bond issue would be a 5-year maturity instrument with a coupon rate of 7 percent to be paid semiannually, whereas the principal repayment occurs at maturity. A comparable financing in U.S. dollars ($) would cost the borrower a coupon rate of 10 percent.

a. Assuming the U.S. dollar depreciates at a rate of 1 percent (0.5 percent semiannually), the effective tax rate of Black & Decker U.S. is 35 percent, and the exchange losses on principal repayments are tax-deductible, which long-term financing option should be selected? On the date of the issue,

€1 = $1.34.

b. Would your answer change if exchange losses on principal repayment were not tax-deductible?

c. A similar financing arrangement with bonds denominated in pound sterling at a coupon rate of 8.5 percent annually is possible. Should Black&Decker U.S.
consider such a financing option? Are there other considerations that could influence your recommendations?