Share
Explore BrainMass

Domestic U.S dollar bearing a coupon rate

Emerson Electric Company manufactures a broad range of electrical and electronic equipment. It has about 200 subsidiaries that operate in more than 2 dozen countries. Emerson is placing increased emphasis on its international operations. International Sales have increased to more than 20% of its total. As part of its international strategy, Emerson has shifted from exporting domestically produced items to manufacturing goods offshore and has nearly doubled its number of foreign plants.
Emerson wants to raise $65 million (or the equivalent in a foreign currency) to finance its overseas expansions. Its debt is rated triple-A. Thus it should be able to borrow funds in virtually any market it chooses. Emerson's investment banker has presented several financing alternatives. These alternatives include three possible two year debt issue, each with a bullet maturity:
1) A domestic U.S dollar issue bearing a coupon rate of 8.65% APR (with interest payable semiannually in arrears)
2) A Swiss franc-denominated Eurobond issue bearing a coupon rate of 4.60% APR (with interest payable annually in arrears)
3) A domestic issue denominated in New Zealand dollars bearing a coupon rate of 18.55% APR (with interest payable semiannually in arrears)
Emerson has subsidiaries operating in both Switzerland and New Zealand, and it realizes free cash flow in Swiss francs and New Zealand dollars. Nevertheless, it intends to hedge fully its currency risk exposure if it issues non U.S dollar debt. Its investment banker has said Emerson would be able to purchase Swiss francs and New Zealand dollars in the futures market at the following prices:
Months Forward 6 12 18 24
Swiss francs/US dollars 1.510 1.470 1.440 1.410
New Zealand/US dollars 1.905 1.992 2.079 2.166

The spot foreign exchange rates are 1.530 Swiss francs per U.S dollar and 1.762 New Zealand dollars per U.S dollar.
Questions
1) How would you explain the pattern of decreasing forward exchange rates for Swiss francs and the pattern of increasing forward exchange rates for New Zealand dollars? Explain why the Swiss franc issue may not be the least expensive, and why the New Zealand dollar issue may not be the most expensive, in spite of their interest rates
2) What principal amount of foreign currency denominated bonds would Emerson have to issue to raise $65 million, assuming it issues bonds denominated in Swiss francs or New Zealand dollars? Specify the debt service stream (principal and interest) for each alternative. Express them in equivalent amounts of U.S dollars.
3) Calculate the cost of borrowing for each alternative. Which has the lowest cost?
4) Suppose the three debt issues require the following flotation costs, which are tax-deductible in the United States on a straight line basis over the life of each issue: 1% for the Swiss franc issue, .75% for the New Zealand dollar issue, and .50% for the U.S dollar issue. Assume a 40% income tax rate for Emerson. Which has the lowest after tax cost?

Attachments

Solution Preview

ANSWERS
Please see attached file for answers.

Months Forward Spot rate 6 12 18 24
Swiss francs/US dollars 1.53 1.510 1.470 1.440 1.410
New Zealand/US dollars 1.762 1.905 1.992 2.079 2.166

Question 1
The decreasing forward exchange rates for SF and $ can be explained2
by a decreasing expected Swiss interest rates.
On the other hand the increasing exchange rates for NZ$ and $ can
be explained by an increasing expected NZ interest rates.

The Swiss issue may not be the least expensive as investors might demand
foreign exchange risk premium thereby equating the yield of the Swiss and other issues.
The New Zealand may not by the most expensive issue as Emerson can design it such
that it can shield ...

Solution Summary

Domestic United States dollar bearing a coupon rate is examined.

$2.19