Luther Industries, a U.S. firm, is considering an investment in Japan. The dollar cost of equity for Luther is 12%. The risk-free interest rates on dollars and yen are r$ = 5.5% and r¥ = 1.5%, respectively. Luther Industries is willing to assume that capital markets are internationally integrated. Luther Industries needs to know the comparable cost of equity in Japanese yen for a project with free cash flows that are uncorrelated with spot exchange rates. The yen cost of equity for Luther Industries is closest to ________.

Question

Quizplus · Accepted Answer

C) Yen cost of equity = [(1 + r¥) / (1 + r$)] × (1 + r$) - 1 = [(1 + 1.5%) / (1 + 5.5%)] × (1 + 12%) - 1 = 0.0775 or 7.75%