Answered step by step
Verified Expert Solution
Link Copied!

Question

1 Approved Answer

4. Cray Research in the U.S. has recently decided to construct a wholly owned manufacturing facility in Bonn, Germany, to manufacture super computers for sale

4. Cray Research in the U.S. has recently decided to construct a wholly owned manufacturing facility in Bonn, Germany, to manufacture super computers for sale in the European Union. The plant is expected to cost 5,500,000, and to take about one year to complete. The plant is to be financed over its economic life of eight years. The borrowing capacity created by this capital expenditure is $2,900,000; the remainder of the plant will be equity financed. Cray Research is not well known in Germany or international bond market; consequently, it would have to pay 7 percent per annum to borrow euros, whereas the normal borrowing rate in the euro zone for well-known firms of equivalent risk is 6 percent. Alternatively, Cray Research can borrow dollars in the U.S. at a rate of 8 percent. The exchange rate has been forecast to be 0.7519 per UD dollar in one year.
The Max Planck Institute in Germany has a mirror-image situation and needs $2,900,000 to finance a capital expenditure of one of its U.S. subsidiaries. It finds that it must pay a 9 percent fixed rate in the United States for dollars, whereas it can borrow euros at 6 percent.
(a) Can you determine if it is mutually beneficial to set up a currency swap between Cray Research and the Max Planck Institute in Germany? Explain.
[2+2 marks]
(b) If your answer is yes to part (a), use a diagram to illustrate the operations of this currency swap, i.e. the flows of funds from the commencement of the currency swap to the maturity of the swap. Explain your diagram.
[2+2+2 marks]
(c) Determine the (re-)exchange of (i) principal sums in the first year; (ii) the annual debt service payments in the first seven years; and (iii) the principal sums and the final debt service payments at maturity. Show all workings.
[2+2+2 marks]
(d) Assume that euro appreciates 1% against the US dollar annually from the second year onwards. (i) How does the euro appreciation affect your answers to part (c)? Explain. (ii) Discuss what possible risks Cray
3 of 4
Research and the Max Planck Institute have to face over the life of the currency swap.

Step by Step Solution

There are 3 Steps involved in it

Step: 1

blur-text-image

Get Instant Access to Expert-Tailored Solutions

See step-by-step solutions with expert insights and AI powered tools for academic success

Step: 2

blur-text-image_2

Step: 3

blur-text-image_3

Ace Your Homework with AI

Get the answers you need in no time with our AI-driven, step-by-step assistance

Get Started

Recommended Textbook for

Corporate Governance And Statutory Audit Stakes And Articulations

Authors: Chefick Olagbèyindé Olafa

1st Edition

6204385682, 978-6204385686

More Books

Students also viewed these Accounting questions