On December 31, 1994, Archimedes SA, the Mexican afflliate of a U.S.

manufacturing company, has the Peso (Ps)-denominated balance sheet shown in table 10.3. The current exchange rate is Ps5 = $1.

(a) One-year peso forward contracts are available in the United States at a 20% discount. Show how the peso translation exposure can be hedged, assuming that exchange losses are tax-deductible at 34% from normal corporate income tax.

(b) Explain how refmancing the long-term debt in dollars at 12.5 % in lieu of the prevailing 35% interest rate on Peso-denominated long-term debt would result in an alternative translation hedge. How does it compare with the contractual hedge introduced in part (a)?

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Table 10.3 Pro-Forma Balance Sheet of Archimedes SA As of December 31, 1994 Assets ('000s of pesos) Liabilities ('000s of pesos) Cash 60,000 Current liabilities 30,000 Accounts receivable 120,000 Long-term debt 255,000 Inventories 120,000 Net fixed assets 240,000 Stockholders' equity 255,000 540,000 540,000