Project #70104 - International Financial Management

Background:

Assume you work for Omega Corporation, a US-based multinational which needs to raise $10 million for a ten year period.  You have been told to analyze and summarize the following alternative scenarios for raising these funds. The company is currently rated AA, and has a pre-tax cost of debt equal to the risk-free rate plus a premium of 0.65%. The company faces a 35% tax rate. Assume the following:

The yield on ten-year treasuries is 1.9261%
The spot rate is $1.09/ €
Inflation in the US is expected to be 2.08% p.a.
Inflation in Europe is expected to be 1.76% p.a.

Scenario 1:

Omega could raise the funds through a traditional bond issue in the United States. They face underwriting costs of 4% of the total amount raised (meaning they only receive 96% of the funds). Assume the coupon rate is equal to the risk-free rate plus a premium of 0.65%.

Scenario 2:

Omega could raise the funds through a traditional bond issue in Europe, then convert the cash into dollars. They would face underwriting costs of 5% of the total amount raised. Assume the coupon rate is equal to the risk-free rate plus a premium of 0.65%.

Scenario 3:

Omega could engage in a zero-coupon swap similar to what Merrill Lynch arranged as one of the tranches for Kodak. In the zero-coupon bond, Omega would receive the full $10MM worth of euros now, but have to pay EU10,500,000 at the end of ten years. The swap would involve an exchange of principal as well as a fixed rate payment in dollars made by Omega to their bank. Assume the payments will be based on 50 bps above the risk-free rate, but that includes all costs (ie, Rf+50 bps is the all-in cost). Assume the investment bank will arrange for a zero-coupon swap with a bank to convert the euros into dollars cash flows paid at a fixed rate = Rf + 50bps.

Instructions:

·       Build a spreadsheet to assess the three scenarios. Explicitly list any assumptions you make.

·       Determine which scenario you would recommend to Omega, and build a one-page executive summary of your reasons why. NOTE: Executives have busy agendas and short attention spans. List bullet points of your reasons instead of writing paragraphs.

·       Make sure to compute the correct yield for each scenario.

·    

Subject Business
Due By (Pacific Time) 05/06/2015 09:00 am
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