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Equity ownership in subsidiary, exchange rates

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16-8:  After all foreign and U.S. taxes, a U.S. corporation expects to receive 3 pounds of dividends per share from a British subsidiary this year. The exchange rate at the end of the year is expected to be $1.60 per pound, and the pound is expected to depreciate 5 percent against the dollar each year for an indefinite period. The dividend (in pounds) is expected to grow at 10 percent a year indefinitely. The parent U.S. corporation owns 10 million share of the subsidiary. What is the present value in dollars of its equity ownership of the subsidiary? Assume a cost of equity capital of 15 percent for the subsidiary.

16-13:  Early in September 1983, it took 245 Japanese yen to equal $1. In August 2002, 19 years later, that exchange rate had fallen to 121 yen to $1. Assume the price of a Japanese manufactured automobile was $9,000 in September 1983 and that its price changes were in direct relation to exchange rates.

a. Has the price, in dollars, of the automobile increased or decreased during the 19-year period because of changes in the exchange rate?

b. What would the dollar price of the automobile be in August 2002, again assuming that the car's price changes only with exchange rates?

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Solution Summary

Answers to2 questions:
1) present value in dollars of equity ownership of a US corporation in its British subsidiary;
2) calculation of price changes of a Japanese manufactured automobile, due to changes in exchange rates,

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16-8:  After all foreign and U.S. taxes, a U.S. corporation expects to receive 3 pounds of dividends per share from a British subsidiary this year. The exchange rate at the end of the year is expected to be $1.60 per pound, and the pound is expected to depreciate 5 percent against the dollar each year for an indefinite period. The dividend (in pounds) is expected to grow at 10 percent a year indefinitely. The parent U.S. corporation owns 10 million share of the subsidiary. What is the present value in dollars of its equity ownership of the subsidiary? Assume a cost of equity capital of 15 percent for the subsidiary.

Growth rate of dividends in pound terms= 10%
Depreciation of pounds= 5%
Growth rate of dividends in dollar terms= =10%-5%= 5% approximate formula
To be more accurate it should be (1.1*0.95-1)=4.5%
but the answer given in this problem corresponds to g=5% as ...

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