Problem 5-14 Kansas Corporation, an American company, has a payment of €6.4 million due to Tuscany Corporation one year from today. At the prevailing spot rate of 0.90 €/$, this would cost Kansas $7,111,111, but Kansas faces the risk that the €/$ rate will fall in the coming year. so that it will end up paying a higher amount in dollar terms. To hedge this risk, Kansas has two possible strategies. Strategy 1 is to buy €6.4 million forward today at a one-year forward rate of 0.89 €/$. Strategy 2 is to pay a premium of $114,000 for a one-year call option on €6.4 million at an exchange rate of 0.88 €/$. a. Suppose that in one year the spot exchange rate is 0.85 €/$. What would be Kansas's net dollar cost for the payable under each strategy? Note: Round your answer to the nearest whole dollar amount. Strategy 1 Strategy 2 Net Dollar Cost s 5,696,000 $ 5,440,000 b. Suppose that in one year the spot exchange rate is 0.95 €/$. What would be Kansas's net dollar cost for the payable under each strategy? Note: Round your answer to the nearest whole dollar amount. Strategy 1 Strategy 2 Net Dollar Cost $ 5,696,000 $ 5,632,000
Problem 5-14 Kansas Corporation, an American company, has a payment of €6.4 million due to Tuscany Corporation one year from today. At the prevailing spot rate of 0.90 €/$, this would cost Kansas $7,111,111, but Kansas faces the risk that the €/$ rate will fall in the coming year. so that it will end up paying a higher amount in dollar terms. To hedge this risk, Kansas has two possible strategies. Strategy 1 is to buy €6.4 million forward today at a one-year forward rate of 0.89 €/$. Strategy 2 is to pay a premium of $114,000 for a one-year call option on €6.4 million at an exchange rate of 0.88 €/$. a. Suppose that in one year the spot exchange rate is 0.85 €/$. What would be Kansas's net dollar cost for the payable under each strategy? Note: Round your answer to the nearest whole dollar amount. Strategy 1 Strategy 2 Net Dollar Cost s 5,696,000 $ 5,440,000 b. Suppose that in one year the spot exchange rate is 0.95 €/$. What would be Kansas's net dollar cost for the payable under each strategy? Note: Round your answer to the nearest whole dollar amount. Strategy 1 Strategy 2 Net Dollar Cost $ 5,696,000 $ 5,632,000
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Shareholders and investors who invest into the capital of the firm desire to have a suitable return on their investment funding. The cost of capital reflects what shareholders expect. It is a discount rate for converting expected cash flow into present cash flow.
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Capital structure is the combination of debt and equity employed by an organization in order to take care of its operations. It is an important concept in corporate finance and is expressed in the form of a debt-equity ratio.
Weighted Average Cost of Capital
The Weighted Average Cost of Capital is a tool used for calculating the cost of capital for a firm wherein proportional weightage is assigned to each category of capital. It can also be defined as the average amount that a firm needs to pay its stakeholders and for its security to finance the assets. The most commonly used sources of capital include common stocks, bonds, long-term debts, etc. The increase in weighted average cost of capital is an indicator of a decrease in the valuation of a firm and an increase in its risk.
Question
Transcribed Image Text:Problem 5-14
Kansas Corporation, an American company, has a payment of €6.4 million due to Tuscany Corporation one year from today. At the
prevailing spot rate of 0.90 €/$, this would cost Kansas $7,111,111, but Kansas faces the risk that the € / $ rate will fall in the coming year.
so that it will end up paying a higher amount in dollar terms. To hedge this risk, Kansas has two possible strategies. Strategy 1 is to
buy €6.4 million forward today at a one-year forward rate of 0.89 €/$. Strategy 2 is to pay a premium of $114,000 for a one-year call
option on €6.4 million at an exchange rate of 0.88 €/$.
a. Suppose that in one year the spot exchange rate is 0.85 €/$. What would be Kansas's net dollar cost for the payable under each
strategy?
Note: Round your answer to the nearest whole dollar amount.
Strategy 1
Strategy 2
Net Dollar Cost
$ 5,696,000
$ 5,440,000
b. Suppose that in one year the spot exchange rate is 0.95 €/$. What would be Kansas's net dollar cost for the payable under each
strategy?
Note: Round your answer to the nearest whole dollar amount.
Strategy 1
Strategy 2
Net Dollar Cost
$
$
5,696,000
5,632,000
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