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Exchange Rates and WACC problems

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1) Suppose 1 Danish krone can be purchased in the spot market for $0.14 today. If the krone appreciated against the dollar by 10% tomorrow, how many krones would a dollar buy tomorrow?

2) Suppose one British pound can purchase 1.82 U.S. dollars today in the foreign exchange market, and currency forecasters predict that the U.S. dollar will depreciate by 12.0% against the pound over the next 30 days. How many dollars will a pound buy in 30 days?

3) Suppose DeGraw Corporation, a U.S. exporter, sold a solar heating station to a Japanese customer at a price of 143.5 million yen, when the exchange rate was 140 yen per dollar. In order to close the sale, DeGraw agreed to make the bill payable in yen, thus agreeing to take some exchange rate risk for the transaction. The terms were net 6 months. If the yen fell against the dollar such that one dollar would buy 154.4 yen when the invoice was paid, what dollar amount would DeGraw actually receive after it exchanged yen for U.S. dollars?

4) Which of the following is NOT a capital component when calculating the weighted average cost of capital (WACC)?

a. Long-term debt.

b. Accounts payable.

c. Retained earnings.

d. Common stock

e. Preferred stock.

5) Hettenhouse Company's perpetual preferred stock sells for $102.50 per share, and it pays a $9.50 annual dividend. If the company were to sell a new preferred issue, it would incur a flotation cost of 4.00% of the price paid by investors. What is the company's cost of preferred stock for use in calculating the WACC (represented as a %)?

6) You were hired as a consultant to Kroncke Company, whose target capital structure is 40% debt, 10% preferred, and 50% common equity. The after-tax cost of debt is 6.00%, the cost of preferred is 7.50%, and the cost of retained earnings is 13.25%. The firm will not be issuing any new stock. What is its WACC (%)?

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1) Suppose 1 Danish krone can be purchased in the spot market for $0.14 today. If the krone appreciated against the dollar by 10% tomorrow, how many krones would a dollar buy tomorrow?

Spot price= $0.14 per Danish krone
Krone appreciates by 10%
Therefore value of 1 Danish krone tomorrow= $0.1540 =(1+0.1) x 0.14

Therefore 1 $ will buy 6.4935 Danish krone =1/0.154

Answer: 6.4935 Danish krone

2) Suppose one British pound can purchase 1.82 U.S. dollars today in the foreign exchange market, and currency forecasters predict that the U.S. dollar will depreciate by 12.0% against the pound over the next 30 days. How many dollars will a pound buy in 30 days?

1 British pound= $1.82
Therefore 1 US dollar= 0.5495 British pound =1/1.82
US dollar depreciates by 12%
Therefore value of 1 US dollar 30 days from now= 0.4836 British pound =(1-0.12) x ...

Solution Summary

Answers 6 questions on Exchange Rates and WACC.

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Foreign Exchange Transactions

Problem 11.3 Seattle Scientific, Inc.

Josh Miller is chief financial officer of a medium-sized Seattle-based medical device manufacturer. The company's annual sales of $40 million have been growing rapidly, and working capital financing is a common source of concern. He has recently been approached by one of his major Japanese customers, Yokasa, with a new payment proposal. Yokasa typically orders ¥12,500,000 in product every other month and pays in Japanese yen. The current payment terms extended by Seattle are 30 days, with no discounts given for early or cash payment. Yokasa has suggested that it would be willing to pay in cash - in Japanese yen - if it was given a 4.5% discount on the purchase price. Josh Miller gathered the following quotes from his bank on current spot and forward exchange rates, and estimated Yokasa's cost of capital.

Assumptions Values
Seattle's 30-day account receivable, Japanese yen 12,500,000
Spot rate, ¥/$ 111.40
30-day forward rate, ¥/$ 111.00
90-day forward rate, ¥/$ 110.40
180-day forward rate, ¥/$ 109.20
Yokasa's WACC 8.850%
Seattle Scientific's WACC 9.200%
Desired discount on purchase price by Yokasa 4.500%

Josh Miller should compare two basic alternatives, both of which eliminate the currency risk.

1. Allow the discount and receive payment in Japanese yen in cash

Account recievable (yen)
Discount for cash payment up-front (4.500%)
Amount paid in cash net of discount

Current spot rate
Amount received in U.S. dollars by Seattle Scientific

2. Not offer any discounts for early payment and cover exposure with forwards

Account receivable (yen)
30-day forward rate
Amount received in cash in dollars, in 30 days

Discount factor for 30 days @ Seattle's WACC
Present value of dollar cash received

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