Question

In: Finance

British Oxygen whose global sales are generally dollar denominated needs to borrow $50,000,000 for working capital...

British Oxygen whose global sales are generally dollar denominated needs to borrow $50,000,000 for working capital and intends using a 5-year multi-currency revolving credit. It can borrow in US$ at 8.5% p.a. or in SFr at 5.5% p.a. However, it expects the SFr to appreciate on average 4% p.a. over the next five years. Using a cash-flow analysis determine in which currency BOC should borrow. Would your answer change if BOC could issue SFr commercial paper supported by the revolving credit at 3.5%?

Solutions

Expert Solution

Here the Spot $ / Sfr rate is not given, so we cannot ascertain exact Amount in $s or SFr. However ,we can findout the effective rates. Based on these effective rates, we can take decision on borrowing. If we borrows in $s, we have to make $50,000,000 X 8.5% = $4,250,000 per year.

the formula for compounding = A (1+i)n, i 8.5% in case of $ borrowal, i = (1.04 X 1.055) = 1.0 if borrowed in $s,

It is assumed that interests are paid every year.

Total Interest payment will be 4,250,000 X 5 = $21,250,000 and principal of $50,000,000 = 71,250,000,

If borrowings in Sfr, the effective interest Expenses in $will be (1.055 X 1.04) - 1 =.0972 ie 9.72% Pa, = $50,000,000 X 9.72% = $4,860,000 , in year 2, it will be $4,860,000 X 1.04 = $5,054,400, in year 3, it will be $5,054,400 X 1.04 =$5,256,576, in year 4, it will be $5,256,576 X 1.04 = $5,466,839.04, in year 5 it will be $5,466,839.04 X 1.04 = $5,685,512.6016 the total interest = $26,323,327.6416 and the total Principal repayment will be equal to $50,000,000 X 1.045= $60,832,645.12. and the total paymant after 5 years will be equal to $26,323,327.6416 + $60,832,645.12 = $87,155,972.7616 the reason for this much increase in repayment is 4% annual appreciation of Sfr and this appreciation will not affect the borrowing are made in dollars, because we are borrowing and repaying using Dollars and not involving convertion of currency.

$87,155,972.7616 - $71,250,000 = $15,905,972.7616

Since Borrowing in SFr will be more costly than borrowing in Dollars by $15,905,972.7616, BOC will borrow in $s

The decision will not change even if interests and principal are paid at the end of 5th year then if borrowed in $s, 50,000,000 X (1.0855) =  75182834.5089062, and if borrowed in SFr it will be Equal to $50,000,000 X (( 1.055 X 1.04)5 = 79650864.9255998, here also borrwal in SFr will make additional costs to the company.

BOC could issue SFr commercial paper supported by the revolving credit at 3.5%,

the formula for compoundind will be same but here i= 1.035 X 1.035 = 1.0764, n = 5

The payment will be at the end of period of Commercial papers, then the re-payment will be ((1.035 X 1.04)5) X 50,000,000 = 72250099.5453002,

Yes answer will change if BOC could issue SFr commercial paper supported by the revolving credit at 3.5%,, then it is better to borrow in SFrs


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