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Carazona Inc. is a U.S. firm that has a large subsidiary 



1. Cost of Foreign Debt Versus Equity. Carazona Inc. is a U.S. firm that has a large subsidiary in Indonesia. It wants to finance the subsidiary- operations in Indonesia. However, the cost of debt
is presently about 30 percent there for firms like Carazona or government agencies that have a
very strong credit rating. A consultant suggests to Carazona that it should use equity financing
there to avoid the high interest expense. He suggests that since Carazona- cost of equity in the
U.S. is about 14 percent, so the Indonesian investors should be satisfied with a return of about 14
percent as well. Clearly explain why the consultant- advice is not logical. That is, explain why
Carazona- cost of equity in Indonesia would not be less than Carazona- cost of debt in
Indonesia.
2. Integrating Cost of Capital and Capital Budgeting. Zylon Co. is a U.S. firm that provides
technology software for the government of Singapore. It will be paid S$7,000,000 at the end of
each of the next five years. The entire amount of the payment represents earnings since Zylon
created the technology software years ago. Zylon is subject to a 30 percent corporate income tax
rate in the United States. Its other cash inflows (such as revenue) are expected to be offset by its
other cash outflows (due to operating expenses) each year, so its profits on the Singapore contract
represent its expected annual net cash flows. Its financing costs are not considered within its
estimate of cash flows. The Singapore dollar (S$) is presently worth $.60, and Zylon uses that spot
exchange rate as a forecast of future exchange rates.
The risk-free interest rate in the United States is 6 percent while the risk-free interest rate in
Singapore is 14 percent. Zylon- capital structure is 60 percent debt and 40 percent equity. Zylon
is charged an interest rate of 12 percent on its debt. Zylon- cost of equity is based on the CAPM.
It expects that the U.S. annual market return will be 12 percent per year. Its beta is 1.5.
Quiso Co., a U.S. firm, wants to acquire Zylon and offers Zylon a price of $10,000,000.
Zylon- owner must decide whether to sell the business at this price and hires you to make a
recommendation. Estimate the NPV to Zylon as a result of selling the business, and make a
recommendation about whether Zylon- owner should sell the business at the price offered.




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