Question

Assume that Seminole, Inc., considers issuing a Singapore dollar?denominated bond at its present coupon rate of 8.7 percent, even though it has no incoming cash flows to cover the bond payments. It is attracted to the low financing rate, since U. S. dollar-denominated bonds issued in the United States would have a coupon rate of 12 percent. Assume that either type of bond would have a four­?year maturity and could be issued at par value. Seminole needs to borrow $10 million. Therefore, it will either issue U. S. dollar denominated bonds with a par value of $10 million or bonds denominated in Singapore dollars with a par value of S$20 million. The spot rate of the Singapore dollar is $.50. Seminole has forecasted the Singapore dollar’s value at the end of each of the next four years, when coupon payments are to be paid:

               End of Year                 Exchange Rate of Singapore Dollar

                                 1                                       $.53

                                 2                                        .56

                                 3                                        .58

                                 4                                        .59

Determine the expected annual cost of financing with Singapore dollars. Should Seminole, Inc., issue bonds denominated in U.S. dollars or Singapore dollars?

*****PLEASE DO NOT DO THIS IN EXCEL MY TEACHER WILL NOT ACCEPT WORK DONE IN EXCEL. I NEED A STEP BY STEP PROCESS VIA WORD DOC OR ANY OTHER TYPE OF WRITTEN LECTURE.*** Thank you

Answer 1

Given that the company does not has any Singapore Dollar (SGD) income, all of the SGD payments shall be converted from USD to SGD. We also know that the cost of USD debt for the company is 12% and the borrowing amount shall be fixed at USD 10 million. Hence the total interest outflow each year shall be USD 1.2 million.

Now, we can solve this problem as below. We will first calculate the annual SGD cash flows and then converty them into USD at the given exchange rates.

Begining:

Borrowing Amount = SGD 20,000,000 and the exchange rate is 0.5. Hence in USD terms the company receives USD 10 million. We calculate basis that the interest is paid at the end of each year.

Year 1:

Interest Payment in SGD = 20,000,000 * 8.7% = SGD 1.74 million. In USD terms this will be (exchange rate 0.53) arrived at by multiplying the SGD interest with the exchange rate. So in USD terms we get interest payment of USD 922,200.

Year 2:

Interest Payment in SGD = 20,000,000 * 8.7% = SGD 1.74 million. In USD terms this will be (exchange rate 0.56) arrived at by multiplying the SGD interest with the exchange rate. So in USD terms we get interest payment of USD 974,400.

Year 3:

Interest Payment in SGD = 20,000,000 * 8.7% = SGD 1.74 million. In USD terms this will be (exchange rate 0.58) arrived at by multiplying the SGD interest with the exchange rate. So in USD terms we get interest payment of USD 1,009,200.

Year 4:

Interest Payment in SGD = 20,000,000 * 8.7% = SGD 1.74 million. In USD terms this will be (exchange rate 0.59) arrived at by multiplying the SGD interest with the exchange rate. So in USD terms we get interest payment of USD 1,026,600.

Now we can compare both the bonds, since we have converted the SGD cash flows also into expected USD equivalent.

SGD Loan	SGD Interest	USD Loan Amount	USD Equivalent Interest	Effective Annual USD Interest Cost
20,000,000	1,740,000	10,000,000	922,200	9.22%
20,000,000	1,740,000	10,000,000	974,400	9.74%
20,000,000	1,740,000	10,000,000	1,009,200	10.09%
20,000,000	1,740,000	10,000,000	1,026,600	10.27%

The company will also have to return the borrowed amount in SGD after 4 years. The loan amount of SGD 20 million in USD terms would have increased to USD 11.8 million (arrived by multiplying the SGD loan amount with exchange rate in year 4 of 0.59).

If we now compare the total cash outflow (without time value) for the company, then in case it borrows in USD terms, it total cash outflow will be USD 1.2 million each year which is total of USD 4.8 million for 4 years (only interest cost to be considered since the bond is to be repaid at face value). But if the commpany borrows in SGD, though the interest cost (in equivalent USD) is lower - it is only USD 3.9324 million but due to appreciation of SGD vs USD, the equivalent USD loan amount to be repaid on maturity increases by USD 1.8 million. Thus the total cash outflow for the compay if it borrows in SGD, in equivalent USD terms will be USD 5.7324 million which is higher than the cash outflow if it borrows in USD.

Hence the company should not borrow in SGD bond.