On May 1, Larkin Hydraulics, a wholly owned subsidiary of Caterpillar (U.S.), sold a 12-megawatt compression turbine to Rebecke-Terwilleger Company of the Netherlands for 4,000,000 payable on August 1. Larkin determined the 4,000,000 price tag on April 1 when the spot rate was $1.0800/. By the time the order was received and booked on May 1, the euro strengthened to $1.100/. Nevertheless, Larkins Director of Finance now wonders if the firm should hedge against a reversal of the recent trend of the euro and proposes the following options:

OPTION 1: Hedge in the forward market The 3-month forward exchange quote is $1.1060/.

OPTION 2: Hedge in the money market Larkin could borrow euros from the Frankfurt branch of its U.S. Bank at 8% per annum.

OPTION 3: Do nothing Larkin could wait until the sales proceeds are received in August, hope the recent strengthening of the euro would continue, and sell the euros received for dollars in the spot market.

If Larkins cost of capital is 12%, what should Larkin do? At what cost of capital would Larkin be indifferent between Options 1 and 2?