Question

Ford can borrow dollars at 12% or Swiss francs at 80% for l year. The peso:dollar exchange rate is expected to move from $1 Fr 1.24 currently to $1 = Fr 1.25 by year's end. (15.10)\

a. What is the expected after-tax dollar cost of borrowing dollars for one year if the Swiss corporate tax rate is 35%?

b. What is Ford's expected after-tax dollar cost of borrowing Swiss francs for one year?

c. At what exchange rate will the after tax Swiss franc cost of borrowing dollars equal the after-tax Swiss franc cost of borrowing francs?

Answer 1

SOLUTION:

A)LET US ASSUME THAT FORD WANTS TO BORROW $ 100000.

CASE1) DOLLAR BORROWING

INTEREST TO BE PAID NET OF TAX AFTER ONE YEAR= $100000*12%(0.6)

NOTE: HERE IT IS ASSUMED THAT TAX RATE IN US IS 40%.

INTEREST (AFTER TAX) = $ 7200.

COST OF BORROWING= 7200/100000*100

= 7.2%

B) CASE 2: SWISS FRANCS BORROWING

INORDER TO GET $ 100000 WE WILL NOW BORROW EQUIVALENT AMOUNT OF SWISS FRANCS USING SPOT RATE= FR 1.24/$

AMOUNT OF SWISS FRANCS TO BE BORROWED=$100000*1.24

= Fr 124000

INTEREST ON BORROWING AFTER TAX= Fr 124000*80%(0.65)

= Fr 64480

TOTAL Fr PAYABLE AFTER 1 YEAR= 124000+64480

= 188480

OUTFLOW OF $ AFTER 1 YEAR WILL BE= 188480/1.25

= $150784

THEREFORE $ COST OF BORROWING Fr= 50784/100000

= 50.784%

C) THE EXCHANGE RATE AT WHICH THE AFTER TAX SWISS FRANC COB $ EQUALS THE AFTER TAX SWISS FRANC COB FRANCS=188480/7200

= Fr 26.18/$