Question Details

Financing and the Currency Swap Decision



1. Financing and the Currency Swap Decision. Bradenton Co. is considering a project in which it
will export special contact lenses to Mexico. It expects that it will receive 1 million pesos after
taxes at the end of each year for the next 4 years, and after that time its business in Mexico will
end as its special patent will be terminated. The peso- spot rate is presently $.20. The U.S. annual
risk-free interest rate is 6% while Mexico- annual risk-free interest rate is 11%. Interest rate
parity exists. Bradenton Co. uses the one-year forward rate as a predictor of the exchange rate in
one year. Bradenton Co. also presumes that the exchange rates in each of the years 2 through 4
will also change by the same percentage as it predicts for year 1. Bradenton searches for a firm
with which it can swap pesos for dollars over each of the next 4 years. Briggs Co. is an importer of
Mexican products. It is willing to take the 1 million pesos per year from Bradenton Co. and will
provide Bradenton Co. with dollars at an exchange rate of $.17 per peso. Ignore tax effects.
Bradenton Co. has a capital structure of 60% debt and 40% equity. Its corporate tax rate is 30%. It
borrows funds from a bank and pays 10% interest on its debt. It expects that the U.S. annual stock
market return will be 18% per year. Its beta is .9. Bradenton would use its cost of capital as the
required return for this project.
a. Determine the NPV of this project if Bradenton engages in the currency swap.
b. Determine the NPV of this project if Bradenton does not hedge the future cash flows.




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