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hinese company makes the decision to proceed with the US business, a U.S. auto company agrees to buy the Chinese company’s manufacturing plant and U.S. sales operations. Assume the following: The US company’s cost of equity is 10%, reflecting a risk free rate of 4% and a beta of 1.2. The cost of debt is 6% and the tax rate is 30%. D/E is 1. The expected RMB/$ will stay at 7 for the next five years. The US Company believes an appropriate adjustment for taking on the international risks is to increase its beta to 1.4. All cash flows will cease after the five years. In other words, the U.S. company is acquiring a five-year annuity of cash flows. Assume the US company will continue to pay taxes in China on the income, and will not have to pay any incremental U.S. taxes.   What is the market risk premium? 5% 4% 6% 10%     What is the expected return on the entire equity market? 6% 10% 9% 12%

hinese company makes the decision to proceed with the US business, a U.S. auto company agrees to buy the Chinese company’s manufacturing plant and U.S. sales operations. Assume the following: The US company’s cost of equity is 10%, reflecting a risk free rate of 4% and a beta of 1.2. The cost of debt is 6% and the tax rate is 30%. D/E is 1. The expected RMB/$ will stay at 7 for the next five years. The US Company believes an appropriate adjustment for taking on the international risks is to increase its beta to 1.4. All cash flows will cease after the five years. In other words, the U.S. company is acquiring a five-year annuity of cash flows. Assume the US company will continue to pay taxes in China on the income, and will not have to pay any incremental U.S. taxes.   What is the market risk premium? 5% 4% 6% 10%     What is the expected return on the entire equity market? 6% 10% 9% 12%

International Financial Management
International Financial Management
14th Edition
ISBN:9780357130698
Author:Madura
Publisher:Madura
Chapter15: International Corporate Governance And Control
Section: Chapter Questions
Problem 24QA
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Chinese company makes the decision to proceed with the US business, a U.S. auto company agrees to buy the Chinese company’s manufacturing plant and U.S. sales operations. Assume the following:

The US company’s cost of equity is 10%, reflecting a risk free rate of 4% and a beta of 1.2.

The cost of debt is 6% and the tax rate is 30%.

D/E is 1.

The expected RMB/$ will stay at 7 for the next five years.

The US Company believes an appropriate adjustment for taking on the international risks is to increase its beta to 1.4.

All cash flows will cease after the five years. In other words, the U.S. company is acquiring a five-year annuity of cash flows.

Assume the US company will continue to pay taxes in China on the income, and will not have to pay any incremental U.S. taxes.

 

  1. What is the market risk premium?
    1. 5%
    2. 4%
    3. 6%
    4. 10%

 

 

  1. What is the expected return on the entire equity market?
    1. 6%
    2. 10%
    3. 9%
    4. 12%

 

  1. What is the Company’s after-tax cost of debt?

 

  1. 0%
  2. 8%
  3. 2%
  4. 10%

 

 

  1. What is the U.S. Company’s cost of equity adjusted for the international risk?

 

  1. 25%
  2. 11%
  3. 14%
  4. 25%

 

  1. What is the U.S. Company’s adjusted WACC for valuing this investment?

 

  1. 6%
  2. 5%
  3. 12%
  4. 25%

 

  1. Assuming the company is using the WACC for its analysis, what is the maximum RMB the company should pay for the operations?

 

  1. 7,180,000,000
  2. 9,700,000,000
  3. 7,840,000,000
  4. 7,940,000,000

 

 

 

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