Question

Cemex, a cement company from Mexico that evaluates all business results, including financing costs, in U.S. dollars. This is done even though the firm is a Mexican corporation; they have significant exposure to the U.S. market. They are listed on the Mexican stock exchange, but have Level III ADRs in the U.S. The company needs to borrow $100,000,000 or the foreign currency equivalent for six years. For all issues, interest is payable once per year, at the end of the year. Available alternatives are listed.

A. Sell Japanese yen bonds at par yielding 3.65% per annum. The current exchange rate is ¥105.5/$, and the yen is expected to strengthen against the dollar by 1.75% per annum.

B. Sell euro-denominated bonds at par yielding 6.75% per annum. The current exchange rate is $1.1945/€, and the euro is expected to weaken against the dollar by 1% per annum.

C. Sell U.S. dollar bonds at par yielding 5.5% per annum.

If the firm currently has bonds outstanding totaling $200,000,000 with an average pretax cost of debt of 6.18%. If the company's average tax rate is 28% what is the new average after-tax cost of debt? (11 points total, 3 points for each bond calculation and 2 points for calculating the new after-tax cost of debt)

Answer 1

	Amount in $	Exc. Rate	Amount in other Currency	Interest	Year end Exc. Rate	Interest Amount in $	Cost of Debt
A	10,00,00,000.00	105.50yen per $	10,55,00,00,000.00	38,50,75,000.00	103.65Yen per $	37,15,012.72	0.037150
B	10,00,00,000.00	$1.19450 per Euro	8,37,17,036.42	56,50,899.96	$1.2064 per Euro	68,17,500.00	0.068175
C	10,00,00,000.00						0.055000

The best alternative is A as it has the lowest cost of debt

After Tax cost of existing debt =0.0618 * (1 - 0.28) = 0.04450 or 4.45%

After Tax cost of new debt = 0.037150 * (1 - 0.28) = 0.0267or 2.67%

Average = (0.04450*(2/3)) + (0.0267*(1/3))

Average = 3.8567%