# Finance: Cross Rates, Purchasing Power Parity, and Cash Budgets

1. Cross Rates

Suppose the exchange rate between U.S. dollars and the Swiss franc is SFr1.5 = $1, and the exchange rate between the dollar and the British pound is £1 = $1.40. What then is the cross rate between francs and pounds? Round your answer to two decimal places.

2. Effective Cost of Trade Credit

The D.J. Masson Corporation needs to raise $700,000 for 1 year to supply working capital to a new store. Masson buys from its suppliers on terms of 2/10, net 90, and it currently pays on the 10th day and takes discounts. However, it could forgo discounts, pay on the 90th day, and get the needed $700,000 in the form of costly trade credit. What is the effective annual interest rate of this trade credit? Assume 365 days in year for your calculations. Do not round intermediate calculations. Round your answer to two decimal places.

3. Purchasing Power Parity

In the spot market, 10.1 pesos can be exchanged for 1 U.S. dollar. A pair of headphones costs $9 in the United States. If purchasing power parity holds, what should be the price of the same headphones in Mexico? Round your answer to two decimal places.

4. Interest Rate Parity

Assume that interest rate parity holds. In both the spot market and the 90-day forward market 1 Japanese yen equals 0.009 dollar. In Japan, 90-day risk-free securities yield 4.1%. What is the yield on 90-day risk-free securities in the United States? Round your answer to two decimal places.

5. Foreign Capital Budgeting

The South Korean multinational manufacturing firm, Nam Sung Industries, is debating whether to invest in a 2-year project in the United States. The project's expected dollar cash flows consist of an initial investment of $1 million with cash inflows of $700,000 in Year 1 and $600,000 in Year 2. The risk-adjusted cost of capital for this project is 10%. The current exchange rate is 1,074 won per U.S. dollar. Risk-free interest rates in the United States and S. Korea are:

1-Year 2-Year

United States 3% 3.75%

S. Korea 2% 2.75%

a. If this project were instead undertaken by a similar U.S.-based company with the same risk-adjusted cost of capital, what would be the net present value generated by this project? Round your answer to the nearest cent.

What would be the rate of return generated by this project? Round your answer to two decimal places.

b. What is the expected forward exchange rate 1 year from now? Round your answer to two decimal places.

What is the expected forward exchange rate 2 years from now? Round your answer to two decimal places.

c. If Nam Sung undertakes the project, what is the net present value and rate of return of the project for Solitaire? Round your answers to two decimal places.

6. Bank Financing

The Raattama Corporation had sales of $3.3 million last year, and it earned a 5% return (after taxes) on sales. Recently, the company has fallen behind in its accounts payable. Although its terms of purchase are net 30 days, its accounts payable represent 62 days' purchases. The company's treasurer is seeking to increase bank borrowings in order to become current in meeting its trade obligations (that is, to have 30 days' payables outstanding). The company's balance sheet is as follows (thousands of dollars):

Cash $100

Accounts payable $600

Accounts receivable 300

Bank loans 700

Inventory 1,400

Accruals 200

Current assets $1,800

Current liabilities $1,500

Land and buildings 600

Mortgage on real estate 700

Equipment 600

Common stock, $0.10 par 300

Retained earnings 500

Total assets $3,000

Total liabilities and equity $3,000

a. How much bank financing is needed to eliminate the past-due accounts payable? Round your answer to the nearest dollar.

b. Assume that the bank will lend the firm the amount calculated in part a. The terms of the loan offered are 8%, simple interest, and the bank uses a 360-day year for the interest calculation. What is the interest charge for one month? (Assume there are 30 days in a month.) Round your answer to the nearest dollar.

c. Now ignore part b and assume that the bank will lend the firm the amount calculated in part a. The terms of the loan are 7.4%, add-on interest, to be repaid in 12 monthly instalments.

1. What is the total loan amount? Round your answer to the nearest dollar.

2. What are the monthly instalments? Round your answer to the nearest dollar.

3. What is the APR of the loan? Round your answer to two decimal places.

4. What is the effective rate of the loan? Round your answer to two decimal places.

d. Would you, as a bank loan officer, make this loan?

7. Cash Budgeting

Dorothy Koehl recently leased space in the Southside Mall and opened a new business, Koehl's Doll Shop. Business has been good, but Koehl has frequently run out of cash. This has necessitated late payment on certain orders, which is beginning to cause a problem with suppliers. Koehl plans to borrow from the bank to have cash ready as needed, but first she needs a forecast of just how much she must borrow. Accordingly, she has asked you to prepare a cash budget for the critical period around Christmas, when needs will be especially high.

Sales are made on a cash basis only. Koehl's purchases must be paid for during the following month. Koehl pays herself a salary of $4,800 per month, and the rent is $2,700 per month. In addition, she must make a tax payment of $14,000 in December. The current cash on hand (on December 1) is $700, but Koehl has agreed to maintain an average bank balance of $4,500 - this is her target cash balance. (Disregard cash in the till, which is insignificant because Koehl keeps only a small amount on hand in order to lessen the chances of robbery.)

The estimated sales and purchases for December, January, and February are shown below. Purchases during November amounted to $160,000.

Sales Purchases

December $150,000 $35,000

January 48,000 35,000

February 56,000 35,000

a. Prepare a cash budget for December, January, and February.

I. Collections and Purchases:

December

January

February

Sales

Purchases

Payments for purchases

Salaries

Rent

Taxes

Total payments

Cash at start of forecast

Net cash flow

Cumulative NCF

Target cash balance

Surplus cash or loans needed

b. Now, suppose Koehl starts selling on a credit basis on December 1, giving customers 30 days to pay. All customers accept these terms, and all other facts in the problem are unchanged. What would the company's loan requirements be at the end of December in this case? (Hint: The calculations required to answer this question are minimal.)

8. Receivables Investment

Snider Industries sells on terms of 3/10, net 25. Total sales for the year are $1,052,500. Thirty percent of the customers pay on the 10th day and take discounts; the other 70% pay, on average, 82 days after their purchases. Assume 365 days in year for your calculations.

a. What is the days sales outstanding? Round your answer to one decimal place.

b. What is the average amount of receivables? Round your answer to the nearest dollar.

c. What would happen to average receivables if Snider toughened up on its collection policy with the result that all non discount customers paid on the 25th day? Round your answer to the nearest dollar.

9. Cross Rates

At today's spot exchange rates 1 U.S. dollar can be exchanged for 11 Mexican pesos or for 111.43 Japanese yen. You have pesos that you would like to exchange for yen. What is the cross rate between the yen and the peso; that is, how many yen would you receive for every peso exchanged? Round your answer to two decimal places.

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#### Solution Summary

This solution contains answers for 9 short questions on cross rate, purchasing power parity, cash budget, international capital budgeting etc.

Economics Health Sector

Firms that discover a new drug (or purchase rights to someone else's discovery) typically apply for and receive a patent on that drug from the government in each country in which the drug might be sold, before going through the expensive and time-consuming development and testing process to bring it to market. These R&D costs can be very large, sometimes in the tens or even hundreds of millions. (Drug companies overstate them, but they are large.) The patent makes it illegal for any other firm to sell that drug without the patent-holder's permission-granting a monopoly on the sales of patented drug. Would-be competitors must either purchase the right to sell the same drug- if the patent-holder is willing to sell- or go through the process of discovering the and developing a slightly different d rug with a more or less similar effect.

a. The conditions of "allocative efficicency" require that the price at which a commodity sells on the market be equal to its marginal cost of production. This equaility is supposed to be ensured for commodities produced by profit-maximizing firms under conditions of perfect competition and free entry. Yet patents represent a deliberate policy to block entry and create a monopoly. Under these conditions, what considerations will determine the price of a patented drug and what relation, if any, will the price bear to the marginal cost of manufacturing and distributing that drug? Show graphically the allocative distortion, the "welfare burden" in terms of Question 1, created by the patent.

b. So why do governments issue patents at all? Explain, showing the contrast between the average and marginal cost curves for a firm with very high fixed costs and low marginal costs, and those assumed for the "standard" textbook firm. What might one predict would happen to the rate of innovation if there were no patent protection? Why? Can you interpret your prediction in terms of trade-ff between short-run and long-run allocative distortions, or "short-run pain for long-run gain"? Be as specific as you can about exactly what society as a whole is giving up, and getting, within the terms of this trade-off.

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