Financing Decision The subsidiaries of Forest Co. produce goods in the United States, Germany, and Australia and sell those goods in the areas where they are produced. Foreign earnings are periodically remitted to the U.S. parent. As the euro’s interest rates have declined to a very low level, Forest has decided to finance its German operations with borrowed funds, which will replace the parent’s equity investment. Forest will transfer its equity investment in the German subsidiary to its Australian subsidiary. These funds will be used to pay off a floating-rate loan, as Australian interest rates have been high and are rising. Explain the expected effects of these actions on the consolidated capital structure and the cost of capital of Forest Co. Given the strategy to be used by Forest, explain how its exposure to exchange rate risk may have changed.

FindFind

International Financial Management

14th Edition
Madura
Publisher: Cengage
ISBN: 9780357130698
FindFind

International Financial Management

14th Edition
Madura
Publisher: Cengage
ISBN: 9780357130698

Solutions

Chapter 17, Problem 19QA
Textbook Problem

Financing Decision The subsidiaries of Forest Co. produce goods in the United States, Germany, and Australia and sell those goods in the areas where they are produced. Foreign earnings are periodically remitted to the U.S. parent. As the euro’s interest rates have declined to a very low level, Forest has decided to finance its German operations with borrowed funds, which will replace the parent’s equity investment. Forest will transfer its equity investment in the German subsidiary to its Australian subsidiary. These funds will be used to pay off a floating-rate loan, as Australian interest rates have been high and are rising.

  1. Explain the expected effects of these actions on the consolidated capital structure and the cost of capital of Forest Co.
  2. Given the strategy to be used by Forest, explain how its exposure to exchange rate risk may have changed.

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