Question

McDougan Associates? (U.S.). McDougan? Associates, a? U.S.-based investment? partnership, borrows

euro€70,000,000 at a time when the exchange rate is 1.3412?/euro€. The entire principal is to be repaid in three? years, and interest is 6.550?% per? annum, paid annually in euros. The euro is expected to depreciate? vis-à-vis the dollar at 3.1?% per annum. What is the effective cost of this loan for? McDougan?

Complete the following table to calculate the dollar cost of the? euro-denominated debt for years 0 through 3. Enter a positive number for a cash inflow and negative for a cash outflow.???(Round the amount to the nearest whole number and the exchange rate to four decimal? places.)

		Year 0		Year 1		Year 2		Year 3
Proceeds from borrowing euros	€	70,000,000
Interest payment due in euros			€	(4,585,000)	€	(4,585,000)	€	(4,585,000)
Repayment of principal in year 3								(70,000,000)
Total cash flow of euro-denominated debt	€	70,000,000	€	(4,585,000)	€	(4,585,000)	€	74,585,000
Expected exchange rate, $/€		1.3412		1.2996		1.2593		1.2202
Dollar equivalent of euro-denominated cash flow	$	93,884,000	$	(5,958,666)	$	(5,773,890)	$	(91,016,076)

What is the effective cost of this loan for? McDougan?

nothing?%

?(Round to two decimal? places.)

Answer 1

Solution:

Let effective cost of loan is r%

Now at effective cost present value of interest and repayment in dollar value discounted at r% will be equal to amount of loan taken dollar value i.e. = $93,884,000

Lets calculate present value of repayments at 3% and 4%

Compuatation of Present value of Repayment
Period	Interest / Principal payment	Effective Rate - 3%		Effective Rate - 4%
		PV Factor	Present Value	PV Factor	Present Value
Year 1	$5,958,666.00	0.970874	$5,785,112.62	0.961538	$5,729,486.54
Year 2	$5,773,890.00	0.942596	$5,442,445.09	0.924556	$5,338,285.87
Year 3	$91,016,076.00	0.915142	$83,292,602.82	0.888996	$80,912,960.14
Total			$94,520,160.53		$91,980,732.56

Therefore effective cost of this loan = 3% + (Present value of repayment at 3% - Loan amount in dollar value) / (Present value of repayment at 3% - Present value of repayment at 4%)

3% + ($94,520,160.53 - $93,884,000) / ($94,520,160.53 - $91,980,732.56)

= 3.25%