Textbook Problem

Financing Decision Cuanto Corp. is a U.S. drug company that has attempted to capitalize on opportunities to expand in Eastern Europe. The production costs in most Eastern European countries are very low, often less than one-fourth of the costs in Germany or Switzerland. Furthermore, there is a strong demand for drugs in Eastern Europe. Cuanto penetrated the Eastern European market by purchasing a 60 percent stake in Galena, a Czech firm that produces drugs.

1. Should Cuanto finance its investment in the Czech firm by borrowing dollars from a U.S. bank that would then be converted into koruna (the Czech currency) or by borrowing koruna from a local Czech bank? What information do you need to know to answer this question?
2. How can borrowing koruna locally from a Czech bank reduce Cuanto’s exposure to exchange rate risk?
3. How can borrowing koruna locally from a Czech bank reduce Cuanto’s exposure to political risk caused by government regulations?