Question

International Finance

A)     Using the currency tables provided in the International Finance Handout (page 9) in Canvas for July 4, 2014 (Friday’s reported price), convert $100,000 to Indian Rupees. You can choose to use either US $ Equivalent or Currency per US $

B)      Using the currency tables provided in the international Finance Handout (pages 8 and 9) in Canvas for June 6th, 2014 and July 4th, 2014 (Friday’s reported price for each), identify whether the US dollar got stronger or weaker relative to the European euro during this time period.

C)      Using the currency tables provided in the International Finance Handout (page 9) in Canvas for July 4th, 2014 (Friday’s reported price), calculate the Russian Ruble/Turkish Lira exchange rate (hint – rubles should be in the numerator).

Cost Of Capital

A)     Explain why debt is typically the cheapest source of financing for the firm and common stock the most expensive (hint – there are two reasons why debt is the cheapest…you should mention them both). Note that the word “Explain” is not the same as “list” – to get full credit

B)      Given the statement in A (debt is typically the cheapest source of financing for the firm and common stock the most expensive), firms that want to minimize their cost of capital should get 99% of their total financing from debt and only 1% from common stock. True or False and explain.

Answer 1

Cost of Capital

Why Is Debt cheaper than equity?

Firstly, Interest on Debt payments is Tax deductible, that is there is no tax on the interest expense paid on Debt, usually corporations tax brackets are close to 35%. Therefore this is one primary reason.

Secondly, Equity is like investors taking on the upside potential of the Corp. as they are part owners of the company's equity, Whereas for debt paying interest and principal at maturity is the obligation that Corp. has, no need to distribute earning potential to the investor.

B) False, A Idle company should although have leverage, it should be limited depending upon economic cycles such as business cycle, interest rates etc. If a company has 99% debt, then interest payments cut through all the earnings a company has, if the Quarter is not good and if the Company cannot break even with interest payments, then that firm can go bankrupt. Therefore ideally company should have a limited leverage, debt should be used ideally in a capital structure however upto a certain limit.