1. L.A. Cellular has received an order for phone switches from Singapore. The switches will be exported under the terms of a letter of credit issued by Sumitomo Bank on behalf of Singapore Telecommunications. Under the terms of the VC, the face value of the export order, $12 million, will be paid 6 months after Sumitomo accepts a draft drawn by L.A. Cellular. The current discount rate on 6-month acceptances is 8.5% per annum, and the acceptance fee is 1.25% per annum. In addition, there is a flat commission, equal to 0.5% of the face amount of the accepted draft, that must be paid if it is sold.
a. How much cash will LA. Cellular receive if it holds the acceptance until maturity?
b. How much cash will it receive if it sells the acceptance at once?
c. Suppose LA. Cellular’s opportunity cost of funds is 8.75% per annum. If it wishes to maximize the present value of its acceptance, should it discount the acceptance?
2. IBM is considering having its German affiliate issue a 10-year, $100-million bond denominated in euros and priced to yield 7 .5%. Alternatively, IBM’s German unit can issue a dollar-denominated bond of the same size and maturity and carrying an interest rate of 6. 7%. (14.5)
a. lf the euro is forecast to depreciate by l. 7% annually, what is the expected dollar cost of the euro denominated bond? How does this compare to the cost of the dollar bond?
b. At what rate of euro depreciation will the dollar cost of the euro-denominated bond equal the dollar cost of the dollar-denominated bond?
c. Suppose IBM’s German unit faces a 35% corporate tax rate. What is the expected after-tax dollar cost of the euro-denominated bond?
3. Ford can borrow dollars at 12% or Swiss francs at 80% for l year. The peso:dollar exchange rate is expected to move from $1 Fr 1.24 currently to $1 = Fr 1.25 by year’s end. (15.10)
a. What is the expected after-tax dollar cost of borrowing dollars for one year if the Swiss corporate tax rate is 35%?
b. What is Ford’s expected after-tax dollar cost of borrowing Swiss francs for one year?
c. At what exchange rate will the after tax Swiss franc cost of borrowing dollars equal the after-tax Swiss franc cost of borrowing francs?
4. Suppose Minnesota Machines (MM) is trying to price an export order from Russia. Payment is due 9 months after shipping. Given the risks involved, MM would like to factor its receivable without recourse. The factor will charge a monthly discount of 2% plus a fee equal to 1.5% of the face value of the receivable for the nonrecourse financing. (15.3)
a. If Minnesota Machines desires revenue of $2.5 million from the sale, after paying all factoring charges, what is the minimum acceptable price it should charge?
b. Alternatively, CountyBank has offered to discount the receivable, but with recourse, at an annual rate of 14% plus a 1% fee. What price will net MM the $2.5 million it desires to clear from the sale?
c. On the basis of your answers to Parts a and b. should Minnesota Machines discount or factor its Russian receivables? MM is competing against Nippon Machines for the order, so the higher MM’s price, the lower the probability that its bid will be accepted. What other considerations should influence MM’s decision?
5. Suppose Navistar’s Canadian subsidiary sells 1,500 trucks monthly to the French affiliate at a transfer price of 527,000 per unit. Assume that the Canadian and French marginal tax rates on corporate income equal 45% and 50%, respectively. (16.1)
a. Suppose the transfer price can be set at any level between $25,000 and $30,000. At what transfer price will corporate taxes paid be minimized? Explain.
b. Suppose the French government imposes an ad valorem tariff of 15% on imported tractors. How would this tariff affect the optimal transfer pricing strategy?
c. If the transfer price of 527,000 is set in euros and the euro revalues by 5%, what will happen to the firm’s overall tax bill? Consider the tax consequences both with and without the 15% tariff.
d. Suppose the transfer price is increased from $27,000 to $30,000 and credit terms are extended from 90 days to 180 days. What are the fund-flow implications of these adjustments?
6. Suppose that DMR SA, located in Switzerland, sells $1 million worth of goods monthly to its affiliate DMR Gmbh, located in Germany. These sales are based on a unit transfer price of $100. Suppose the transfer price is raised to $130 at the same time that credit terms are lengthened from the current 30 days to 60 days. (16.3)
a. What is the net impact on cash flow for the first 90 days? Assume that the new credit terms apply only to new sales already booked but uncollected.
b. Assume that the tax rate is 25% in Switzerland and 50% in Germany and that revenues are taxed and costs deducted upon sale or purchase of goods, not upon collection. What is the impact on after-tax cash flows for the first 90 days?