Project Financing Strategy Konk Co., a U.S. firm, considers a project in which it would build a subsidiary in Belgium that would generate net cash flows of approximately 10 million euros per year for five years and would remit that amount to the parent each year. Konk Co. has no other international business. It needs approximately 20 million euros as the initial outlay to establish the subsidiary. It can finance this initial outlay in the following ways and the subsidiary would repay the amount of the investment evenly over the next five years: (a) The parent can borrow dollars from a U.S. bank and convert them to euros; (b) the parent can borrow euros from a Belgian bank; (c) the parent can use its equity (retained earnings from existing business in the United States) and convert the funds into euros; (d) the parent can borrow dollars from a Belgian bank and convert them to euros; and (e) the parent can diversify its financing by obtaining one-fourth of the funds from each of the preceding sources. Assume that there is no cost advantage to any financing method. If Konk Co. wants to use a financing method to minimize its project’s exposure to exchange rate risk, which method should it use? Briefly explain.

FindFind

International Financial Management

14th Edition
Madura
Publisher: Cengage
ISBN: 9780357130698
FindFind

International Financial Management

14th Edition
Madura
Publisher: Cengage
ISBN: 9780357130698

Solutions

Chapter 14, Problem 33QA
Textbook Problem

Project Financing Strategy Konk Co., a U.S. firm, considers a project in which it would build a subsidiary in Belgium that would generate net cash flows of approximately 10 million euros per year for five years and would remit that amount to the parent each year. Konk Co. has no other international business. It needs approximately 20 million euros as the initial outlay to establish the subsidiary. It can finance this initial outlay in the following ways and the subsidiary would repay the amount of the investment evenly over the next five years: (a) The parent can borrow dollars from a U.S. bank and convert them to euros; (b) the parent can borrow euros from a Belgian bank; (c) the parent can use its equity (retained earnings from existing business in the United States) and convert the funds into euros; (d) the parent can borrow dollars from a Belgian bank and convert them to euros; and (e) the parent can diversify its financing by obtaining one-fourth of the funds from each of the preceding sources. Assume that there is no cost advantage to any financing method. If Konk Co. wants to use a financing method to minimize its project’s exposure to exchange rate risk, which method should it use? Briefly explain.

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