Sensitivity of Foreign Project Risk to Capital Structure Texas Co. produces pharmaceutical drugs and plans to acquire a subsidiary in Poland. This subsidiary, a laboratory, would perform biotechnology research. Texas Co. is attracted to the lab because of the cheap wages paid to scientists in Poland. The parent of Texas Co. would review the lab research findings of the Polish subsidiary when deciding which drugs to produce and would then manufacture the drugs in the United States. The expenses incurred in Poland will represent half of the total expenses incurred by Texas Co. All drugs produced by Texas Co. are sold in the United States, and this situation would not change in the future.
Texas Co. has considered three ways to finance the acquisition of the Polish subsidiary. First, it could use 50 percent equity funding (in dollars) from the parent and 50 percent borrowed funds in dollars. Second, it could use 50 percent equity funding (in dollars) from the parent and 50 percent borrowed funds in Polish zloty. Third, it could use 50 percent equity funding by selling new stock to Polish investors denominated in Polish zloty and 50 percent borrowed funds denominated in Polish zloty. Assuming that Texas Co. decides to acquire the Polish subsidiary, which financing method would minimize the exposure of Texas to exchange rate risk? Explain.
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