Now consider the case of another company:

U.S. Robotics Inc. has a current capital structure of 30% debt and 70% equity. Its current before-tax cost of debt is 10%, and its tax rate is 45%. It currently has a levered beta of 1.10. The risk-free rate is 2.5%, and the risk premium on the market is 7%.

U.S. Robotics Inc. is considering changing its capital structure to 60% debt and 40% equity. Increasing the firm’s level of debt will cause its before-tax cost of debt to increase to 12%. Use the Hamada equation to unlever and relever the beta for the new level of debt. What will the firm’s weighted average cost of capital (WACC) be if it makes this change in its capital structure? (Hint: Do not round intermediate calculations.)   

Which of the following statements regarding a firm’s optimal capital structure are true? Check all that apply.

The optimal capital structure minimizes the firm’s WACC.

The optimal capital structure maximizes the firm’s EPS.

The optimal capital structure minimizes the firm’s cost of debt.

The optimal capital structure maximizes the firm’s stock price.

The optimal capital structure minimizes the firm’s cost of equity.

Natural Mosaic. Natural Mosaic Company (U.S.) is considering investing Rs50,000,000 in India to create a wholly owned tile manufacturing plant to export to the European market. After five years, the subsidiary would be sold to Indian investors for Rs100,000,000. A pro forma income statement for the Indian operation predicts the generation of Rs7,000,000 of annual cash flow, is listed in the following table.

The initial investment will be made on December 31, 2011, and cash flows will occur on December 31st of each succeeding year. Annual cash dividends to Natural Mosaic from India will equal 75% of accounting income.

The U.S. corporate tax rate is 40% and the Indian corporate tax rate is 50%. Because the Indian tax rate is greater than the U.S. tax rate, annual dividends paid to Natural Mosaic will not be subject to additional taxes in the United States. There are no capital gains taxes on the final sale. Natural Mosaic uses a weighted average cost of capital of 14% on domestic investments, but will add six percentage points for the Indian investment because of perceived greater risk. Natural Mosaic forecasts the rupee/dollar exchange rate on December 31st for the next six years as listed below.

What is the net present value and internal rate of return on this investment?

Please show calculations!

3. Dow Company manufactures tables in U.S. The standard (budgeted) cost of one unit is shown below:

*The variable manufacturing overhead rate is based on direct labour hour.

During March, 8,000 units were produced. The company purchased 80,000 pounds of direct materials at a cost of $300,000. There are 7,400 pounds of these materials were unused at the end of March. No materials were on hand at the beginning of March.

In March, the selected data relating to the production is listed below:

Joe, the vice president of Dow Company, asked you to evaluate how effective operations have been during the month of March                                                                                

Required:

1. For direct materials, compute the price variance and quantity variance for March. Calculate the total direct materials variances.

2. Based on the variable manufacturing overhead efficiency variance, determine actual labor hours and actual labor rate during March.

3. For variable manufacturing overhead, compute the spending variance for March,

4. Compute direct labor rate variance and direct labor efficiency variance for March.

5. The purchase department manager bought cheaper materials in March to see whether costs could be reduced. Do you think this plan could reduce costs? Why?

On January 1, 2016, Safetyway Group, a U.S. company, formed a Swiss subsidiary, TEurope AG. The subsidiary issued all of its currently outstanding common stock on that date. Selected accounts from its balance sheets on December 31, 2016 and 2017, all of which are shown in Swiss francs (CHF), are as follows:

December 31

Additional Information:

1. Exchange rates are as follows:

2. An analysis of inventories, for which the FIFO inventory method is used, is as follows:

3. On January 1, 2016, TEurope purchased land for CHF24,000 and plant and equipment for CHF140,000. On July 4, 2017, additional equipment was purchased for CHF30,000. Plant and equipment is depreciated on a straight-line basis over a ten-year period with no salvage value. A full year’s depreciation is taken in the year of purchase.

Required

a. Prepare a schedule remeasuring the selected accounts above into U.S. dollars (the functional currency) at December 31, 2017, and December 31, 2016, respectively. Show supporting computations in good form.

b. Prepare a schedule translating the selected accounts above into U.S. dollars at December 31, 2017, and December 31, 2016, assuming the Swiss franc is the functional currency.

A U.S. company does business with a special purpose entity, formed to complete a one-year project. Qualitative factors are inconclusive regarding whether the SPE is a variable interest entity, so the company asks you to do a quantitative analysis. Here is information on expected cash flows for the SPE at the end of one year:

Expected Cash Flows Probability

$3,000,000 0.70

1,200,000 0.20

600,000 0.10

The SPE was formed with an investment of $2,000,000, financed with $1,750,000 in debt and $250,000 in equity. A discount rate of 20% is appropriate, given the project’s risk.

Required

a. Is this SPE a variable interest entity, based on your quantitative analysis? Show calculations clearly and explain your answer.

b. How could management manipulate the numbers to change the answer to Part a.?

c. If the answer to Part a. is “yes,” how should the company decide if it should consolidate the SPE?

d. If the answer to Part a. is “no,” how should the company decide if it should consolidate the SPE?

Gymson is an Italian subsidiary of U.S. company Universal Playgrounds, Inc.

Gymson began operations on January 1,2018. Its comparative balance sheets for January 1 and December 31, 2018, are presented below in euros:

                                                                                       1/1/18       12/31/18

Cash and receivables                                             € 10,000       € 20,000

Inventories, at cost 40,000          90,000

Noncurrent assets, net 700,000      530,000

Total assets €750,000      €640,000

Liabilities €550,000      €420,000

Capital stock 200,000      200,000

Retained earnings 0                 20,000

            Total liabilities and equity                       €750000       €640,000

During 2018, the following events occurred:

Sales revenue was €2,000,000, earned evenly during the year.

Inventory purchases were €1,200,000, made evenly over the year.

Out-of-pocket operating expenses were €650,000, incurred evenly throughout the year.

Depreciation expense on equipment was €170,000.

Dividends of €10,000 were declared and paid when the exchange rate was $1.52/€

REQUIRED: Calculate the translation gain/loss or the remeasurement gain/loss under each of the following assumptions. Be sure to clearly identify which it is and whether it is a gain or loss.

Assume Gymson’s functional currency is the euro.

Assume Gymson’s functional currency is the U.S. dollar.

Relevant exchange rates are as follows:

January 1, 2018                  $1.40

2018 average                      1.50

December 31, 2018          1.55

On June 1, Parker-Mae Corporation (a U.S.-based company) received an order to sell goods to a foreign customer at a price of 145,000 francs. Parker-Mae will ship the goods and receive payment in three months, on September 1. On June 1, Parker-Mae purchased an option to sell 145,000 francs in three months at a strike price of $1.12. The company designated the option as a fair value hedge of a foreign currency firm commitment. The option's time value is excluded in assessing hedge effectiveness, and the change in time value is recognized in net income. The fair value of the firm commitment is measured by referring to changes in the spot rate (discounting to present value is ignored). Relevant exchange rates and option premiums for the franc are as follows:

Parker-Mae Corporation must close its books and prepare its second-quarter financial statements on June 30.

1. Prepare journal entries for the foreign currency option, foreign currency firm commitment, and export sale.

2. What is the impact on net income in each of the two accounting periods?

3. What is the amount of net cash inflow resulting from the sale of goods to the foreign customer?

WestGas​ Conveyance, Inc., is a large U.S. natural gas pipeline company that wants to raise​ $120 million to finance expansion. WestGas wants a capital structure that is 50​% debt and 50​% equity. Its corporate combined federal and state income tax rate is 30​%. WestGas finds that it can finance in the domestic U.S. capital market at the rates listed:

Both debt and equity would have to be sold in multiples of​ $20 million, and these cost figures show the component​ costs, each, of debt and equity if raised 50​% by debt and 50​% by equity. A London bank advises WestGas that U.S. dollars could be raised in Europe at the following​ costs, also in multiples of​ $20 million, while maintaining the 50/50 capital structure.

Each increment of cost would be influenced by the total amount of capital raised. That​ is, if WestGas first borrowed​ $20 million in the European market at 8​% and matched this with an additional​ $20 million of​ equity, additional debt beyond this amount would cost 11​% in the United States and 10​% in Europe. The same relationship holds for equity financing.

a. Calculate the lowest average cost of capital for each increment of​ $40 million of new​ capital, where WestGas raises​ $20 million in the equity market and an additional​ $20 in the debt market at the same time.

b. If WestGas plans an expansion of only​ $60 million, how should that expansion be​ financed? What will be the weighted average cost of capital for the​expansion?

WestGas​ Conveyance, Inc., is a large U.S. natural gas pipeline company that wants to raise​ $120 million to finance expansion. WestGas wants a capital structure that is 50​% debt and 50​% equity. Its corporate combined federal and state income tax rate is 36​%. WestGas finds that it can finance in the domestic U.S. capital market at the rates listed:

Both debt and equity would have to be sold in multiples of​ $20 million, and these cost figures show the component​ costs, each, of debt and equity if raised 50​% by debt and 50​% by equity. A London bank advises WestGas that U.S. dollars could be raised in Europe at the following​ costs, also in multiples of​ $20 million, while maintaining the 50/50 capital structure. Each increment of cost would be influenced by the total amount of capital raised. That​ is, if WestGas first borrowed​ $20 million in the European market at 8​% and matched this with an additional​ $20 million of​ equity, additional debt beyond this amount would cost 13​% in the United States and 12​% in Europe. The same relationship holds for equity financing.

a. Calculate the lowest average cost of capital for each increment of​ $40 million of new​ capital, where WestGas raises​ $20 million in the equity market and an additional​ $20 in the debt market at the same time.

b. If WestGas plans an expansion of only​ $60 million, how should that expansion be​ financed? What will be the weighted average cost of capital for the​expansion?

BAY Co., a U.S. corporation, purchased inventory on credit from a German company on March 18, 2017 for 50,000 Euros. BAY Co. made payment of 50,000 Euros on May 17, 2017. The exchange rate was €1 = $1.27 on April 18, €1 = $1.30 on April 30; and €1 = 1.28 on May 17.

Prepare the journal entry to record the sale as of April 18?

What amount of foreign exchange gain or loss, if any, should be recorded on April 30^th monthly statements from this transaction? If there is a foreign exchange gain or loss prepare the journal entry.

Prepare the Journal entry to record BAY’S payment of the payable on May 18^th

What is the total CUMULATIVE gain or loss BAY Co. recognizes on this transaction?