Question
Cantoon Co. is considering the acquisition of a unit from the French government. Its initial outlay would be $4 million. it will reinvest all the
Cantoon Co. is considering the acquisition of a unit from the French government. Its initial outlay would be $4 million. it will reinvest all the earnings in the unit. it expects that at the end of eight years, it will sell the unit for 12 million euros after capital gains taxes are paid. The spot rate of the euro is $1.20 and is used as the forecast of the euro in the future years. Cantoon has no plans to hedge its exposure to exchange rate risk. The annualized US risk-free interest rate is 5% regardless of the maturity of the debt, and the annualized risk-free interest rate on euros is 7%, regardless of the maturity of the debt. Assume that interest rate parity exists. Cantoon`s cost of capital is 25%. It plans to use cash to make acquisitions.
A. Determine the NPV under these conditions.
B. Rather than use all cash, Cantoon could partially finance the acquisition. It could obtain a loan of 3 million euros today that would be used to cover a portion of the acquisition. In this case, it would have to pay a lump-sum total of 7 million euros at the end of eight years to repay the loan. There are no interest payments on this debt. This financing deal is structured such that none of the payment is tax deductible. Determine the NPV if Cantoon uses the forward rate instead the spot rate to forecast the future spot rate of the euro and elects to partially finance the acquisition. You need to derive the eight year forward rate for this acquisition.
Step by Step Solution
There are 3 Steps involved in it
Step: 1
Get Instant Access with AI-Powered Solutions
See step-by-step solutions with expert insights and AI powered tools for academic success
Step: 2
Step: 3
Ace Your Homework with AI
Get the answers you need in no time with our AI-driven, step-by-step assistance
Get Started