Foreign Exchange Risk and the Cost of Borrowing Swiss Francs. The chapter demons
ID: 2656857 • Letter: F
Question
Foreign Exchange Risk and the Cost of Borrowing Swiss Francs. The chapter demonstrated that a firm borrowing in a foreign currency could potentially end up paying a very different effective rate of interest than what it expected. Using the same baseline values of a debt principal of SF 1.7 ?million, a? one-year period, an initial spot rate of SF 1.4600/$, a 4.919?% cost of? debt, and a 32% tax? rate, what is the effective? after-tax cost of debt for one year for a U.S.? dollar-based company if the exchange rate at the end of the period? was:
a.SF1.4600?/$
b. SF1.4100/$
c. SF1.3560?/$
d. SF1.5950?/$
Explanation / Answer
Answer a) If the exchange rate remian same
We first calculate the percentage change in the exchange rate,s S2 = 1.4600
s= (S1-S2)/S2x100 = 0.000%
We then calculate the after tax effective cost of debt after exchange rate changes
Ke ={ (1+ ke (1-t) x (1+s) } -1 = 3.3449%
Answer b) If the exchange rate ends the period with SF1.4100/$
We first calculate the percentage change in the exchange rate,s S2 = 1.4100/$
s= (S1-S2)/S2x100 = 3.546%
We then calculate the after tax effective cost of debt after exchange rate changes
Ke ={ (1+ ke (1-t) x (1+s) } -1 = 7.0095%
Answer c) If the exchange rate ends the period with SF1.3560?/$
We first calculate the percentage change in the exchange rate,s S2 = 1.3560/$
s= (S1-S2)/S2x100 = 3.982%
We then calculate the after tax effective cost of debt after exchange rate changes
Ke ={ (1+ ke (1-t) x (1+s) } -1 = 7.4601%
Answer d) If the exchange rate ends the period with SF1.5950?/$
We first calculate the percentage change in the exchange rate,s S2 = 1.5950/$
s= (S1-S2)/S2x100 = -14.984%
We then calculate the after tax effective cost of debt after exchange rate changes
Ke ={ (1+ ke (1-t) x (1+s) } -1 = - 12.1403%