Chapter 17, Problem 26QA

a) An Australian company has total assets of $150 million and debt of $30 million. The firm's before-tax cost of debt is 5% and its cost of equity is 12%. If the corporate tax rate is 30%, calculate the firm's cost of capital and the appropriateness of its use as a discount rate in capital budgeting.  (b) Assume AUD = 0.58 GBP and inflation is 3.5% pa in Australia and 7% pa in Great Britain. Estimate the AUD/GBP spot rate in one year's time and comment on the accuracy of this estimate.

FOREIGN CAPITAL BUDGETING Sandrine Machinery is a Swiss multinationalmanufacturing company. Currently, Sandrine’s financial planners are consideringundertaking a 1-year project in the United States. The project’s expected dollardenominated cash flows consist of an initial investment of $2,000 and a cash inflow thefollowing year of $2,400. Sandrine estimates that its risk-adjusted cost of capital is 10%.Currently, 1 U.S. dollar will buy 0.94 Swiss franc. In addition, 1-year risk-freesecurities in the United States are yielding 3%, while similar securities in Switzerlandare yielding 1.50%.a. If this project was instead undertaken by a similar U.S.-based company with the samerisk-adjusted cost of capital, what would be the net present value and rate of returngenerated by this project?b. What is the expected forward exchange rate 1 year from now?c. If Sandrine undertakes the project, what is the net present value and rate of return of theproject for Sandrine?

A U.S. company can borrow 10,000 pounds in Great Britain for 6% interest, paying back 10,600 pounds in one year. Alternatively, the U.S. company can borrow an equivalent amount of U.S dollars in the United States and pay 13% interest. Assuming capital markets are efficient, estimate the expected inflation rate in the United States if inflation in Great Britain is expected to be zero.