Description
For the questions below please show the working, and do provide brief explanation as to how you came up with answer and what is going on? they look detailed to provide you all the information
1. Lucy’s is a US based restaurant chain that is expanding to Malaysia. Lucy’s can either borrow from a Malaysian bank at 9.55% (in MYR) or from a US bank at 5.50%. The spot rate is USD 0.3560 = MYR 1. The one-year forward rate is USD 0.3425 = MYR 1. If Lucy’s wants the lowest cost (interest rate in USD terms) loan for their US based shareholders, which loan should Lucy’s take?
2. Eight-Mile Electric Motor Co. (EMEM) manufactures electric motors for electric and hybrid cars in their plant in Detroit, Michigan, USA. One of EMEM’s biggest markets is in Europe. EMEM competes with a French producer of electric motors, Citreonic Electric Motor Co. On January 1, 2016, the exchange rate was $1.2250/€. On January 1, 2017 the exchange rate was $1.2150/€. The US experienced a 6.5% inflation rate over that time period. France’s inflation was 3.0%. Assume that EMEM’s manufacturing costs increased at the rate of US inflation. Assume that Citreonic’s costs increased at the rate of French inflation. Did one company gain an advantage over their competitor due to the change in exchange rates? Please show all calculations needed to come to your conclusion.
Explanation & Answer
Hi, please find the answers in the attached PDF. I have used an hypothetical scenario to explain the reasoning.
1. Suppose Lucy requires RM1,000,000 to expand into Malaysia. Lucy has two options, to either
borrow from a U.S. bank or a Malaysian Bank.
If Lucy borrows from a U.S. bank
a. Borrow amount in US$ equivalent to RM1,000,000. At the spot rate of RM0.356/$, this equals to:
= RM1,000,000 * 0.356 = $356,000
b. The interest + capital on the borrowed amount after one year equals to:
= $356,000 * 1.055 = $375,580
If Lucy borrows from a Malaysian bank
a. Borrow RM1,000,000 from the Malaysian bank
b. The interest + capital on the borrowed amount after one year 9.55% is equal to
= RM1,000,000 * 1.0955 = RM1,095,500
c. Convert into $US using the forward exchange rate of RM0.3425/$, this equals to:
= RM1,095,500 * 0.3425 = $375,209
The interest + capital ...
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