TropiKana Inc., a U.S firm, has just borrowed euro 1,000,000 to make improvements to an Italian fruit plantation and processing plant. If the interest rate is 5.50% per year and the Euro appreciates against the dollar from $1.40/euro at the time the loan was made to $1.45/euro at the end of the first year, what is the before tax cost of capital if the firm repays the entire loan plus interest (rounded)?

Question

Quizplus · Accepted Answer

To calculate the before tax cost of capital we need to calculate the interest payment in euros and convert it to dollars using the end of year exchange rate.

First, calculate the interest payment:
Interest payment = euro 1,000,000 x 5.50% = euro 55,000

Next, convert the interest payment to dollars using the end of year exchange rate:
Interest payment in dollars = euro 55,000 / 1.45 = $37,931

The total amount to be repaid at the end of the year is euro 1,055,000.
Using the end of year exchange rate, this is equivalent to $1,529,750.

The before tax cost of capital can be calculated as:
Before tax cost of capital = (Interest payment + (Total amount repaid - Loan amount)) / Loan amount
Before tax cost of capital = ($37,931 + ($1,529,750 - $1,400,000)) / $1,400,000
Before tax cost of capital = 9.27%

Therefore, the answer is D) 9.27%.