Chapter 18 International Capital Budgeting

1. Before you pose these next seven questions to your students, give consideration to their
finance backgrounds. At my school (University of Missouri at olumbia! capital budgeting
questions in this level of detail "ould be #fair game# because the students have had plenty of
capital budgeting before in a prior finance course. $ust glancing at equations %&'% through %&'(f
is not preparation for these seven questions. )here are plenty of easier questions in this test
bank.
Tiger Towers, Inc. is considering an expansion of their existing business, student apartments. The
new project will be built on some vacant land that the firm has just contracted to bu. The land
cost !1,""",""" and the pament is due toda. Construction of a #"$unit office building will cost
pretax !% million& this expense will be depreciated straight$line over %" ears to 'ero salvage
value& the value of the land and building in ear %" will be !18,""",""". The !%,""","""
construction cost is to be paid toda. The project will not change the ris( level of the firm. The
firm will lease #" offices suites at !#",""" per suite per ear& pament is due at the start of the
ear& occupanc will begin in one ear. )ariable cost is !%,*"" per suite. +ixed costs, excluding
depreciation, are !,*,""" per ear. The project will re-uire a !1",""" investment in net wor(ing
capital.

#. .hat is the unlevered after$tax incremental cash flow for ear "/
0. $!%,11","""
B. $!*,1"","""
C. $!2,""","""
D. $!2,"1","""
3. 4one of the above
$!2,"1",""" 5 $ 6!1,""",""" 7 !%,""",""" 7 1","""8
%. .hat is the unlevered after$tax incremental cash flow for ear #/
0. $!2,11"
B. !1"#,%""
C. !#"#,%""
9. !#**,"""
3. 4one of the above

2. .hat is the unlevered after$tax incremental cash flow for ear %"/
0. !1#,2%#,%""
B. !1#,##*,%:"
C. !1#,%%#,%""
9. !1#,28*,"""
3. 4one of the above
!1#,2%#,%"" 5 !#"#,%"" 7 return of 4.C 7 building;land
#"#,%"" 7 !1",""" 7 !18,""",""" $ ".%2 <!18,""",""" $ !1,""","""=
4otice that the answer to -uestion * is a function of the student>s answer to -uestion 2?
Correct response to @*
5 response to @2 7 !1",""" 7 !18,""",""" $ ".%2 <!18,""",""" $ !1,""","""=
Aou ma wish to award partial credit based on the following rubric?
1#,2%#,%"" if @2 5 c=
1#,##*,%:" if @2 5 a=
1#,%%#,%"" if @2 5 b=
!1#,28*,""" if @2 5 d=
0warding partial credit on a multiple choice test isn>t hard. Import their responses into 3xcel. Bse
CifC statements. The advantage of path$dependent grading is that ou can get the same level of
discrimination in grading on a multiple choice test as on an essa test.
*. +or the next % -uestions, assume that the firm will partiall finance the project with a
!%,""",""" interest$onl %"$ear loan at 1"." percent 0DE with annual paments.
.hat is the levered after$tax incremental cash flow for ear "/
A. $!1,"1","""
B. $!1,""","""
C. $!11","""
9. $!#,1"","""
3. 4one of the above
*+" 5 !%,""",""" $ response to @%
= $!1,"1","""
Aou ma wish to award partial credit on this -uestion according to the following rubric
$!1,"1",""" is correct if @%5 2=
$!1,""",""" is correct if @% 5 %=
$!11",""" is correct if @% 5 1=
$!#,1"",""" is correct if @% 5 #=

1. +or the next % -uestions, assume that the firm will partiall finance the project with a
!%,""",""" interest$onl %"$ear loan at 1"." percent 0DE with annual paments.
.hat is the levered after$tax incremental cash flow for ear 1/
A. !2,%""
B. $!#"#,11"
C. $!:*,,""
9. !*,,"""
3. 4one of the above
Aour response to @2 $ !%"",""" ".11
4ote? ou ma wish to award partial credit according to?
!2,%"" is correct if @2 5 %=
$!#"#,11" is correct if @2 5 1=
$!:*,,"" is correct if @2 5 #=
!*,,""" is correct if @2 5 2=
,. +or the next % -uestions, assume that the firm will partiall finance the project with a
!%,""",""" interest$onl %"$ear loan at 1"." percent 0DE with annual paments.
.hat is the levered after$tax incremental cash flow for ear %"/
0. !:,"#,,%:"
B. !:,#%2,%""
C. !:,1%2,%""
9. !:,#8,,"""
3. 4one of the above
the right answer is our response to @* $ !%"",""" ".11 $ !%,""","""
Aou should consider awarding partial credit on this according to this rubric?
!:,"#,,%:" is correct if @* 5 #=
!:,#%2,%"" is correct if @* 5 1=
!:,1%2,%"" is correct if @* 5 %=
!:,#8,,""" is correct if @* 5 2=
8. 0ssume that the firm will partiall finance the project with a subsidi'ed !%,""",""" interest
onl %"$ear loan at 8." percent 0DE with annual paments. 4ote that eight percent is less than
the 1" percent that the normall borrow at. .hat is the 4D) of the loan/
0. !1:8,21:
B. !*%,:,:.8%
C. !1"#,,#,.**
D. !1,%%2,8*1.":
3. 4one of the above
Bsing the cash flow menu on a financial calculator?
C+" 5 !%,""","""
C+1 5 $!1*8,2"" 5 $!%,""",""" "."8 .11
+"1 5 #:
C+# 5 $!%,1*8,2""
I 5 1"F
4D) 5 !1,%%2,8*1.":

:. The firm>s tax rate is %2F. The firm>s pre$tax cost of debt is 8F& the firm>s debt$to$e-uit ratio
is %& the ris($free rate is %F& the beta of the firm>s common stoc( is 1.*& the mar(et ris( premium
is :F. .hat is the firm>s cost of e-uit capital/
0. %%.%%F
B. 1".8*F
C. 1%.1#F
D. 11.*F
3. 4one of the above
re-uit 5 %F 7 1.* :F 5 11.*F
1". The firm>s tax rate is %2F. The firm>s pre$tax cost of debt is 8F& the firm>s debt$to$e-uit
ratio is %& the ris($free rate is %F& the beta of the firm>s common stoc( is 1.*& the mar(et ris(
premium is :F. .hat is the re-uired return on assets/
0. %%.%%F
B. 1".8*F
C. 1%.1#F
9. 11.*F
3. 4one of the above
11.*F 5 rasset 7 % 6 rasset $ rdebt8 <1$.%2=
rasset 5 1".8*F
11. +or the next two -uestions consider a project with the following data

The *$ear project re-uires e-uipment that costs !1"",""". If underta(en, the shareholders will
contribute !#",""" cash and borrow !8",""" at 1F with an interest$onl loan with a maturit of
* ears and annual interest paments. The e-uipment will be depreciated straight$line to 'ero
over the *$ear life of the project. There will be a pre$tax salvage value of !*,""". There are no
other start$up costs at ear ". 9uring ears 1 through *, the firm will sell #*,""" units of product
at !*& variable costs are !%& there are no fixed costs.
1#. .hat is the 4D) of the project using the .0CC methodolog/
0. !2:,11%."%
B. !*8,"#8.18
C. !1"#,,#,.**
9. %1*,111.11
3. 4one of the above
Bsing the cash flow menu of a financial calculator? C+" 5 $!1"","""& C"1 5 !%:,8""& +"1 5 2&
C"# 5 !2%,1""& I 5 r.0CC 5 8.,2& 4D) 5 !*8,"#8.18

1%. .hat is the 4D) of the project using the 0D) methodolog/
0. !2:,11%."%
B. !1:8,21:
C. !1"#,,#,.**
D. !12:,*8".1#
3. 4one of the above
0D) 5 $Cost 7 Base$case 4D) 7 4D) depreciation tax shield 7 4D) interest tax shield 5
The project does not cost !1"",""" but rather !:8,:%,.2: 5 $!1"",""" 7 !1,"1#.*1
<1"",""" less the present value of after tax salvage value discounted at rasset 5 1#F=

+or the next % -uestions consider a project with the following data

The *$ear project re-uires e-uipment that costs !1"",""". If underta(en, the shareholders will
contribute !#*,""" cash and borrow !,*,""" with an interest$onl loan with a maturit of * ears
and annual interest paments. The e-uipment will be depreciated straight$line to 'ero over the *$
ear life of the project. There will be a pre$tax salvage value of !*,""". There are no other start$
up costs at ear ". 9uring ears 1 through *, the firm will sell #*,""" units of product at !*&
variable costs are !%& there are no fixed costs.

12. .hat is the 4D) of the project using the .0CC methodolog/
0. !*8,"#8.18
B. !2:,11%."%
C. !28,%"".2,
9. !1"#,,#,.**
3. 4one of the above
Bsing the cash flow menu of a financial calculator? C+" 5 $!1"","""& C"1 5 !%:,8""& +"1 5 2&
C"# 5 !2%,1""& I 5 r.0CC 5 11.#"& 4D) 5 !28,%"".2,

1*. .hen using the 0D) methodolog, what is the 4D) of the depreciation tax shield/
0. !%#,"*1.*#
B. !#*,,,,.%*
C. !##,,:2.1*
9. !:,,1*#.:8
3. 4one of the above
Bsing a financial calculator>s cash flow menu? 4 5 *& DGT 5 !1,8"" 5 !#",""" .%2 I;AE 5 rdebt
5 1"F& ,-depreciation tax shield 5 !#*,,,,.%*

11. .hen using the 0D) methodolog, what is the 4D) of the interest tax shield/
A. !:,111.*1
B. !1#,"1:.%#
C. !:,%,,.%1
9. !,,""".,%
3. 4one of the above
using a financial calculator, 4 5 *& DGT 5 !#,**" 5 .1" !,*,""" .%2& I;AE 5 rdebt 5 1"F&
D)interest tax shield 5 !:,111.*1

1,. Toda is Hanuar 1, #"":. The state of Iowa has offered our firm a subsidi'ed loan. It will be
in the amount of !1",""",""" at an interest rate of *F and have 044B0I <amorti'ing=
paments over % ears. The first pament is due toda and our taxes are due Hanuar 1 of each
ear on the previous ear>s income. The ield to maturit on our firm>s existing debt is 8F.
.hat is the 0D) of this subsidi'ed loan/
4ote that I did not round m intermediate steps. If ou did, our answer ma be off b a bit.
Jelect the answer closest to ours.
0. $!%,2:,,##2.2%
B. !21,,#"1."*
C. !82",,:,
9. 4one of the above
+irst, get our financial calculator into begin mode and 1 pament per ear?
D) 5 1",""","""
45 %
I5 *F
DGT 5 $!%,2:,,##2.2%
0morti'e the loan
The si'e and timing of the cash flows of the loan are?
C+" 5 !1,*"#,,,*.*,
C+1 5 $!%,%81,1,,.#2
C+# 5 $!%,22",1"#.,"
I5 8F& 4D) 5 !21,,#"1."*
If ou are covering 0D) in detail, this (ind of -uestion is appropriate. 0lternative versions of
this are nearb.

18. Toda is Hanuar 1, #"":. The state of Iowa has offered our firm a subsidi'ed loan. It will be
in the amount of !1",""",""" at an interest rate of *F and have 044B0I <amorti'ing=
paments over % ears. The first pament is due 9ecember %1, #"": and our taxes are due
Hanuar 1 of each ear on the previous ear>s income. The ield to maturit on our firm>s
existing debt is 8F. .hat is the 0D) of this subsidi'ed loan/
4ote that I did not round m intermediate steps. If ou did, our answer ma be off b a bit.
Jelect the answer closest to ours.
0. $!%,2:,,##2.2%
B. !21,,#"1."*
C. !82",,:,
9. 4one of the above
+irst, enter the loan into a financial calculator and solve for the pament?
D)51",""","""
45 %
I5 *F
DGT 5 %,1,#,"8*
Then amorti'e the loan?
4ow find the 0D) of the loan as shown in the boo(?
C+" 5 !1",""","""
C+15 $!%,*"#,"8* 5 $!%,1,#,"8* $ .11 !*"","""
C+#5 $!%,**1,"11
C+%5 $!%,11#,1%#
I5 8F
4D) 5 !82",,:,

1:. The re-uired return on assets is 18F. The firm can borrow at 1#.*F& firm>s target debt to
value ratio is %;*. The corporate tax rate is %2F, and the ris($free rate is 2F and the mar(et ris(
premium is :.# percent. .hat is the weighted average cost of capital/
0. 1#.1*F
B. 1%."#F
C. 12.%%F
9. #%.2*F
3. 4one of the above
.l 5 #%.2*F 5 18F 7 1.* <18F $ 1#.*F= <1 $ .%2=
weighted average cost of capital 5 #;* #%.2*F 7 %;* <1#.*F= <1 $ .%2=
5 12.%%F
#". Aour firm is in the %2F tax brac(et. The ield to maturit on our existing bonds is 8F. The
state of Keorgia offers to loan our firm !1,""",""" with a T.L ear 0GLETIMI4K loan at a
*F rate of interest and 044B0I paments due at the 349 L+ TN3 A30E.
The interest will be deductible at the time that ou pa. .hat is the 0D) of this below$mar(et
loan to our firm/ I did not round an of m intermediate steps. Aou might be a little bit off. Dic(
the answer closest to ours.
A. !12,1*,.%8
B. !21,,#"1."*
C. !82",,:,
9. 4one of the above
+irst, enter the loan into a financial calculator to find the pament?
D)51,""","""
45 #
I5 *F
DGT 5 *%,,8"2.88
4ext amorti'e the loan to find out how much interest is paid in each period <it>s deductible=
+inall, find the 0D) of the loan as the 4D) of the after$tax cash flows at 8F?
C+" 5 !1,""","""
C+15 $!*#",8"2.88 5 $!28,,8"2 $ .11 !*","""
C+#5 $!*#:,":, 5 $!*1#,1:*$ .11 !#*,1":.,1
I5 8F
4D) 5 !12,1*,.%8

#1. The firm>s tax rate is %2F. The firm>s pre$tax cost of debt is 8F& the firm>s debt$to$e-uit
ratio is %& the ris($free rate is %F& the beta of the firm>s common stoc( is 1.*& the mar(et ris(
premium is :F.Calculate the weighted average cost of capital.
0. %%.%%F
B. 8.":F
C. :."#F
9. 11.*F
3. 4one of the above
NOTE TO FACULTY: the next six -uestions are similar to the six that follow them, but have
different answers as the debt$e-uit ratio changes from # to %. This can discourage cheating,
especiall if ou onl give credit to students who have the right answers on the right testO
Consider a project of the Cornell Naul Goving Compan, the timing and si'e of the incremental
after$tax cash flows <for an all$e-uit firm= are shown below in millions?

The firm>s tax rate is %2F& the firm>s bonds trade with a ield to maturit of 8F& the current and
target debt$e-uit ratio is #& if the firm were financed entirel with e-uit, the re-uired return
would be 1"F

##. Bsing the 0D) method, what is the value of the debt side effects/
0. !#%:,",#,1*#.,"
B. !11,8:1,,1%.11
C. !*:,2*:,%"1."%
9. !11",""","""
3. 4one of the above
C+" 5 11",""","""& C+1 5 $%2,828,""" 5 ."8 !11",""",""" <1 $ .%2=& +"1 5 % C+# 5 $
!1:2,828,""" 5 $!11",""",""" $ ."8 !11",""",""" .11& Bse I 5 8F

4LT3 TL +0CBITA? the next six -uestions are similar to the last six, but have different
answers as the debt$e-uit ratio changed from # to %. This can discourage cheating, especiall if
ou onl give credit to students who have the right answers on the right testO
Consider a project of the Cornell Naul Goving Compan, the timing and si'e of the incremental
after$tax cash flows <for an all$e-uit firm= are shown below in millions?

The firm>s tax rate is %2F& the firm>s bonds trade with a ield to maturit of 8F& the current and
target debt$e-uit ratio is %& if the firm were financed entirel with e-uit, the re-uired return
would be 1"F
#%. Bsing the weighted average cost of capital methodolog, what is the 4D)/ I didn>t round m
intermediate steps. If ou do, ou>re not going to get the right answer.
A. $!1,2"1,%"1.#*
B. !1#,2:2,12%.,*
C. !%1,*8",,1,.**
9. !1"8,::2.118.#"
3. !*:,2*:,%"1."%
)he "eighted average cost of capital is
re-uit 5 1"F 7 % <1"F $ 8F= <1 $ .%2= 5 1%.:1F
r.0CC 5 1%.:1F .#* 7 8F .,* .11 5 ,.2*F

4LT3 TL +0CBITA? the next six -uestions are similar to the last six, but have different
answers as the debt$e-uit ratio changed from # to %. This can discourage cheating, especiall if
ou onl give credit to students who have the right answers on the right testO
Consider a project of the Cornell Naul Goving Compan, the timing and si'e of the incremental
after$tax cash flows <for an all$e-uit firm= are shown below in millions?

The firm>s tax rate is %2F& the firm>s bonds trade with a ield to maturit of 8F& the current and
target debt$e-uit ratio is %& if the firm were financed entirel with e-uit, the re-uired return
would be 1"F
+or the next * -uestions, the firm will partiall finance the project with an 8F interest$onl 2$
ear loan.

#2. .hat is the levered after$tax incremental cash flow for ear #/
A. !18*,,:1,"""
B. !#1*,1*#,"""
C. !#1,,:*#,"""
9. !#82,828,"""
3. 4one of the above
*+# 5 !1:",1*#,"""
5 !##*,""",""" $ ."8 !,2#,*"",""" <1 $ .%2=
#*. .hat is the levered after$tax incremental cash flow for ear 2/
A. $!#81,,"2,"""
B. !21*,1*#,"""
C. $!1:2,828,"""
9. !21",,:1,"""
3. 4one of the above
*+* 5 $!#81,,"2,"""
5 !*"",""",""" $ !,2#,*"",""" $ ."8 !,2#,*"",""" <1 $ .%2=
#1. Bsing the flow to e-uit methodolog, what is the value of the e-uit claim/
0. $!1,*2","""
B. !221,*,",811.""
C. !%1,*8",,1,.**
9. !2,",:*%,%:%.,"
E. !%",,11,#%1.1%
9iscount the levered cash flows at re-uit 5 1%.:1F
IC+ " 5 $#2,,*"","""& IC+ 1 5 8*,,:1,"""&
C+# 5 18*,,:1,"""& C+% 5 %%*,,:1,"""&
C+2 5 $#81,,"2,"""
#,. Bsing the 0D) method, what is the value of this project to an all$e-uit firm/
0. $!21,*"#,#88.1"
B. !1#,2:2,12%.,*
C. !%1,*8",,1,.**
D. $!1,,11%,22*.1#
3. !*:,2*:,%"1."%
9iscount the unlevered cash flows at rasset 5 1"F

#8. Bsing the 0D) method, what is the value of the debt side effects/
0. !#%:,",#,1*#.,"
B. !11,8:1,,1%.11
C. !*:,2*:,%"1."%
9. !11",""","""
3. 4one of the above
C+" 5 ,2#,*"","""& C+1 5 $%:,#"2,""" 5 ."8 !,2#,*"",""" <1 $ .%2=& +"1 5 %
C+# 5 $!,81,,"2,""" 5 $ !,2#,*"","""$ ."8 !,2#,*"",""" .11
Bse I 5 8F
#:. Aour firm>s existing bonds trade with a ield to maturit of eight percent. The state of
Gissouri has offered to loan our firm !1",""",""" at 'ero percent for five ears. Eepament
will be of the form of !#,""",""" per ear for five ears the first pament is due in one ear.
.hat is the value of this offer/
0. !2,,#:,1##.,*
B. !#,"12,*,:.:%
C. !"
9. !1:1,:#:.88
3. 4one of the above
Bsing a financial calculator? 4 5 *& I;A 5 8F DGT 5 $!#,""",""" solve for D) 5 !,,:8*,2#".",
The state is giving ou !1",""",""" for a promise that>s worth onl !,,:8*,2#".",. The value of
that is !#,"12,*,:.:%
%". .hat proportion of the firm is financed b debt for a firm that expects a 1*F return on
e-uit, a 1#F return on assets, and a 1"F return on debt/ The tax rate is #*F.
0. #"F
B. 1;%
C. 1"F
D. #;%
3. 8"F
+rom Godigliani$Giller Droposition II <perhaps not displaed to its best advantage in footnote #,
but surel something students (now coming into the course= we can find the debt$e-uit ratio.
.ith a debt e-uit ratio, it>s eas to find debt to value?
%1. The re-uired return on e-uit for a levered firm is 1".1"F. The debt to e-uit ratio is P the
tax rate is 2"F, the pre$tax cost of debt is 8F. +ind the cost of capital if this firm were financed
entirel with e-uit.
A. 1"F
B. 1#F
C. 8.1,F
9. 4one of the above
+rom Godigliani and Giller proposition # the re-uired return on e-uit for a levered firm is .l 5
.u 7 <1$ =<.u $ i=<9ebt;3-uit=
Instructors note? some students will select b= the .0CC. Jtudents who have had corporate
finance should (now GQG proposition #. Kood -uestions for graduate courses.

%#. The re-uired return on e-uit for an all$e-uit firm is 1"."F. The are considering a change
in capital structure to a debt$to$e-uit ratio of P the tax rate is 2"F, the pre$tax cost of debt is
8F. +ind the new cost of capital if this firm changes capital structure.
0. 12.:%F
B. 8.1,F
C. ,.2"F
9. 4one of the above
+rom Godigliani and Giller proposition # that the re-uired return on e-uit for a levered firm is
.l 5 .u 7 <1$ =<.u $ i=<9ebt;3-uit=
Instructors note? Jtudents who have had corporate finance should (now GQG proposition #. 0
common mista(e will be a=& a grievous mista(e confusing 9;3 and 9;) would be c=. Kood
-uestions for graduate courses.R
%%. The re-uired return on e-uit for an all$e-uit firm is 1"."F. The currentl have a beta of
one and the ris($free rate is *F and the mar(et ris( premium is *F. The are considering a
change in capital structure to a debt$to$e-uit ratio of P the tax rate is 2"F, the pre$tax cost of
debt is 8F. +ind the beta if this firm changes capital structure.
0. 1.1#
B. 1
C. ,.2F
9. 4one of the above
+rom Godigliani and Giller proposition #? .l 5 .u 7 <1$ =<.u $ i=<9ebt;3-uit=
Instructors note? Jtudents who have had corporate finance should (now GQG proposition # and
the difference between an asset beta and an e-uit beta. Kood -uestions for graduate courses.

%2. .hat is the expected return on e-uit for a tax$free firm with a 1*F expected return on
assets that pas 1#F on its debt, which totals #*F of assets/
0. #2F
B. 1*.1"F
C. 11F
9. #"F
3. 1*.,*F
Jtart with debt$to$value ratio of #*F, find debt$to$e-uit ratio, then use
.l 5 .u 7 <1$ =<.u $ i=<9ebt;3-uit=
%*. .hat is the expected return on e-uit for firm in the 2"F tax brac(et with a 1*F expected
return on assets that pas 1#F on its debt, which totals #*F of assets/
0. #2F
B. 1*.1"F
C. 11F
9. #"F
3. 1*.,*F
Jtart with debt$to$value ratio of #*F, find debt$to$e-uit ratio, then use
.l 5 .u 7 <1$ =<.u $ i=<9ebt;3-uit=

%1. 0ssume that SAM Corporation is a leveraged compan with the following information?
.l 5 cost of e-uit capital for SAM 5 1%F
i 5 before$tax borrowing cost 5 8F
t 5 marginal corporate income tax rate 5 %"F
Calculate the debt$to$total$mar(et$value ratio that would result in SAM having a weighted
average cost of capital of :.%F.
0. %*F
B. 2"F
C. 2*F
D. *"F
3-uation 1,.1
Iet / 5 debt$to$total$mar(et$value ratio
".":% 5 <1 $ /0-= ".1% 7 /0- <1 $ ".%"= "."8
".":% 5 ".1% $ ".1%/0- 7 /0- ".," "."8
".1%/0- $ "."*1 /0- 5 ".1% $ ".":%
".",2/0- 5 "."%,
/0- 5 ".*" 5 *"F

%,. Toda is Hanuar 1, #"":. The state of Iowa has offered our firm a subsidi'ed loan. It will be
in the amount of !1",""",""" at an interest rate of *F and have 044B0I <amorti'ing=
paments over % ears. The first pament is due toda and our taxes are due Hanuar 1 of each
ear on the previous ear>s income. The ield to maturit on our firm>s existing debt is 8F.
.hat is the 0D) of this subsidi'ed loan/ 1ote that 2 did not round my intermediate steps. 2f you
did, your ans"er may be off by a bit. 3elect the ans"er closest to yours.
A. !2"1,"#%.1"
B. !82",,:,
C. !12,1*,.%8
9. !#",1*:.,,
3. 4one of the other answers are within !1"" of m answer
+irst, get into begin mode
and 1 pament per ear?
D) 5 1",""","""
45 %
I5 *F
DGT 5 $!%,2:,,##2.2%
0morti'e the loan
The si'e and timing of the cash flows of the loan are?
C+" 5 !1,*"#,,,*.*,
C+1 5 $!%,2:,,##2.2%
C+# 5 $!%,%81,11,.#2
C+% 5 $!*1,1#1.,%
I5 8F
4D) 5 !2"1,"#%.1"

%8. 0n Italian firm is considering selling its line of coin$operated cappuccino machines in the
B.T. The business ris( will be identical to the firm>s existing line of business in the euro 'one,
the cost of capital in the euro 'one is iU 5 1"F. The expected inflation rate over the next two
ears in the B.T. is %F per ear and #F per ear in the euro 'one. The spot exchange rates are
!1.8" 5 1."" and !1.1* 5 U1.""
The pound sterling denominated cash flows are as follows?

.hat is the U$denominated 4D) of this project/ I did not round m intermediate steps, if ou
did, select the answer closest to ours.
A. U*,*1%.#%
B. U#,#,".,:
C. U,,##%.12
9. U%,**2.#:
3. There is not enough information <e.g. B.J. inflation= to do this problem.
the appropriate cost of capital for the firm to use on these $denominated cash flows is
Bse that discount rate in the cash flow menu of a financial calculator with C+" 5 $1"","""& C+1
5 #*,"""& C+# 5 1"","""& 4D) 5 %,**2.#8,,
+inall translate to pounds at the spot cross rate? Gost students will ta(e this approach?
.here the ear$1 cash flow is given b
, and the ear$two cash flow is
given b
These euro$denominated cash flows have an 4D) of exactl U*,*1%.#%. Jtudents who ta(e this
approach have lots of room for grievous rounding errors.

%:. The spot exchange rate is 1#* 5 !1. The B.J. discount rate is 1"F& inflation over the next
three ears is %F per ear in the B.J. and #F per ear in Hapan. Calculate the dollar 4D) of this
project.

I did not round m intermediate steps, if ou did, select the answer closest to ours.
0. !#1,,181.8,
B. !12,1,1.1,
C. !#,*%1.2:
D. !#,1%,.21
3. 4one of the above
the eas wa to do this is to estimate the en$denominated re-uired return
The en$denominate cash flows given above ield an 4D) 5 #1,,181.8,, which converts to
!#,1%,.21 at the spot exchange rate.
In the alternative, ou could convert the cash flows at the exchange rates expected to prevail over
the next three ears
.hen discounted at 1"F this series of dollar$denominated cash flows has 4D) 5 !#,1%,.21
Jtudents prefer ta(ing this approach, but the do tend to ma(e a great deal of rounding errors.
2". 0s of toda, the spot exchange rate is U1."" 5 !1.#* and the rates of inflation expected to
prevail for the next ear in the B.J. is #F and %F in the euro 'one. .hat is the one$ear forward
rate that should prevail/
A. U1."" 5 !1.#%,:
B. U1."" 5 !1.#1%:
C. U1."" 5 !".::"%
9. !1."" 5 U1.#1#%
Ta(e the spot rate and gross up each side b the respective inflation rates

21. 0s of toda, the spot exchange rate is U1."" 5 !1.*" and the rates of inflation expected to
prevail for the next ear in the B.J. is #F and %F in the euro 'one. .hat is the one$ear forward
rate that should prevail/
0. U1."" 5 !1.*12,
B. U1."" 5 !1.28*2
C. U1."" 5 !".11"#
9. !1."" 5 U".11"#
Ta(e the spot rate and gross up each side b the respective inflation rates

0s of toda, the spot exchange rate is U1."" 5 !1.#* and the rates of inflation expected to prevail
for the next three ears in the B.J. is #F and %F in the euro 'one. .hat spot exchange rate
should prevail three ears from now/
0. U1."" 5 !1.#%,:
B. U1."" 5 !1.#1%:
C. U1."" 5 !".::"%
9. !1."" 5 U1.#1#%
Ta(e the spot rate and gross up each side b the respective inflation rates