Question

Foreign Exchange Risk and the Cost of Borrowing Swiss Francs. The chapter demonstrated that a firm borrowing in a foreign currency could potentially end up paying a very different effective rate of interest than what it expected. Using the same baseline values of a debt principal of SF1.5 million, a one year period, an initial spot rate of SF1.5000/$, a 5.000% cost of debt, and a 34% tax rate, what is the effective cost of debt for one year for a U.S. dollar-based company if the exchange rate at the end of the period was:

SF1.5000/$

SF1.4400/$

SF1.3860/$

SF1.6240/$

Answer 1

	Debt Principal in $
	= Debt Principal in Swiss Francs / Spot Exchange Rate
	= SF 1,500,000 / SF 1.50
	= $1,000,000
	Amount of Interest after Tax in Swiss Francs
	= Principal Amount * Cost of Debt * (1- Tax Rate)
	= SF 1,500,000 * 5% * (1-34%)
	= SF 75000 * 0.66
	= SF 49500
	Particulars	Exchange Rate at the end of Year
		SF 1.50	SF 1.44	SF 1.3860	SF 1.6240
A.	Amount of Interest in SF	49,500.00	49,500.00	49,500.00	49,500.00
B.	Exchange Rate at the end of Year	1.5000	1.4400	1.3860	1.6240
C.	Amount of Interest in $ (A / B)	33,000.00	34,375.00	35,714.29	30,480.30
D.	Debt Principal in $	$1,000,000.00	$1,000,000.00	$1,000,000.00	$1,000,000.00
E.	Cost of Debt	3.30%	3.44%	3.57%	3.05%
	(Amount of Interest / Debt Principal *100) (C / D *100)