2 questions to be answered

International Financial Management (FIN6605.U21)

Summer 2021

Test # 2

(MNC cost of capital and foreign project financing, MNC capital budgeting and international

portfolio diversification)

This is an open-book assignment that is due by midnight (11:59pm) ET on Wednesday, July 21,

2021. Please submit your work via file upload in Assignments on Canvas or send your work as an

email attachment to [email protected]. The test contains two parts. Answer all questions. Show all

your work.

Part I: Answer all 7 questions. Total points= 28, i.e. 4pts/question .

(1) Suppose you have a friend who is a US investor owning a portfolio that consists of about 5

stocks, mostly local (FL) firms. Your friend asks you for advice with regards to instructions

on how to diversify her portfolio. What can you tell her?

(2) Are MNCs supposed to hedge all their foreign currency exposures using foreign exchange

derivatives? Provide a detailed answer.

(3) Consider a US firm, Calcio Inc., that operates in the Italy, Brazil, Hong Kong, and Japan.

Provide a simple model that the managers of Calcio Inc. firm can use to estimate the firm’s

foreign exchange exposure. Be as detailed as possible. Explain what the model can reveal

about the nature of the Calcio Inc.’s exposure to foreign currency risk.

(4) What makes multinational firms special? What are some of the reasons why they have

dominated markets over such long period of time?

(5) Firm A is a US firm that operates in France, Italy, Belgium, Netherlands, Austria and Spain.

Firm B is also a US firm that operates in India, China, Brazil, Mexico, Germany, and

Australia. Assume that both firms are in the same industry and that their financial

characteristics (size, leverage, profitability etc.) are not significantly different. Which of the

two companies do you believe will be more likely to experience a more significant operating

exposure to currency risk? What methods of operating exposure management can you

recommend as better suited for Firm A and for Firm B?

(6) An Australian firm is considering a project in Indonesia. The managers of the Australian

firm are trying to estimate the project’s cost of capital. Can you help? Please provide detailed

advice.

(7) A large Japanese multinational that has penetrated the US market and a medium-size

Indian firm that is mainly selling its products in Asia are considering cross-listing their

shares in the US via ADRs that would trade on the NASDAQ. What are the possible

motivations for the decision to cross-list in the case of the Japanese and the Indian firm?

What do you expect would be the two firm’s stock price reaction to the cross-listing news?

Part II: Problem solving. Answer all five problems and show all your work. Total points=72, i.e. 15 points for each problem, except for problem # 1 which is worth 12 points.

(1) At the end of 2020 you bought 750 shares of a Brazilian stock at a price of 220 Brazilian Real

(BR) per share. At that time the spot exchange rate was 0.2128$/BR. Eight months later, you

sold these shares for 320.5 BR/share. If your US-$ holding period rate of return on that

investment was 12.5%, what was the exchange rate when you sold the Brazilian firm’s

shares?

(2) Toshiyuki Matsukawa is production manager for Tanaka Chemicals, a Japanese chemical

manufacturer operating throughout Asia. He is considering a proposal to build a chemical

plant in Thailand to service the growing Southeast Asian market. the project information is

as follows:

a. The exchange rate is currently S0Bt/¥ = 0.2500 Bt/¥.

b. The manufacturing plant will cost Bt 4 million and will take one year to construct.

Assume the Bt 4 million cost will be paid in full at the end of the year (at t=1).

c. The real value of the manufacturing plant is expected to remain at Bt 4 million

throughout the life of the project. The plant is to be sold at project’s end.

d. Production begins in one year (at t=1) with annual; revenues of Bt 100 million per

year (in nominal terms) over the 4-year life of the project. Fixed costs are

contractually fixed in nominal terms at Bt 5million each year over the life of the

project. Variable costs are 90 percent of gross revenues. Assume end-of-year cash

flows.

e. The plant will be owned by a subsidiary in Thailand and will be depreciated to zero

on a straight-line basis.

f. Taxes are 40% in Thailand.

g. The annual inflation rate is expected to be 10% in Thailand and 5% in Japan.

h. The required rate of return on similar projects in Thailand is 20%.

i. Assume that the international parity conditions hold.

Answer the following questions:

i. Calculate the Thai Bhat (Bt) value of this investment proposal from the local

(Thai) point of view.

ii. What is the nominal required rate of return for similar projects in Japan?

iii. Identify the expected future spot exchange rates for each cash flow.

iv. Calculate the yen value of the project from the local and parent perspective.

Are the answers equivalent? Why?

(3) GDZ, a Norwegian firm, has systematic risk of 0.95 when measured against the MSCI World

Market Index. Its systematic risk is 1.15 when measured against the Norwegian stock index.

The expected returns on the MSCI world index and the Norwegian index are 8.75% and

11.35% respectively. The annual risk-free rate in the Norway is 3.5% and GDZ’s corporate

tax rate is 46%. Consider the following two scenarios about the Norwegian capital market:

Scenario #1: The Norwegian market is integrated with the rest of the world.

Under this scenario GDZ can borrow in the Eurobond market at 5.25% and

international investors are willing to tolerate a 60% debt ratio at this cost of debt.

Scenario #2: The Norwegian market is segmented from the rest of the world

Under this scenario GDZ can borrow in Norway at 5.96% interest rate and maintain

a debt ratio of 2/3.

a. What is the required rate of return on the GDZ’s stock under scenario #1 and

scenario #2?

b. What is GDZ’s weighted average cost of capital under scenario #1 and scenario #2?

c. Suppose that GDZ is expected to generate before-tax operating cash flow of 250

million Norwegian krone (NOK) at the end the next year. This cash flow is expected

to grow at 5% perpetually. What is the value of GDZ under scenario #1 and scenario

#2?

(4) Suppose a project by a US firm in in Brazil is expected to generate a $7 million annuity over

5 years from an initial investment of $20 million. If the required return on this investment is

10%, how large does the probability of expropriation in year 4 have to be before the

investment has a negative NPV? Assume that all cash inflows occur at the end of each year

and that the expropriation, if it occurs, will occur prior to the year 4 cash flow or not at all. In

the event of expropriation, neither the year 4 cash flow nor the year 5 cash flow will occur.

(5) The Indian subsidiary of BDC, a US multinational, has the opportunity to invest in one of

two mutually exclusive machines. Both machines can produce the same product for the

Indian market. Machine A has a life of 9 years, costs 120 million Indian Rupees (IRP) and

will produce after-tax inflows of 25 million IRP per year at the end of each year. Machine B

has a life of 7 years, costs 150 million and will produce after-tax inflows of 35 million IRP per

year at the end of each year. Assuming the machines can be replaced indefinitely at constant

prices, which machine should BCD choose? Assume a cost of capital of 12%. The current spot

rate is 0.013 US$/IRP.