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/€ at the time the loan was made to $1.45/€ 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 paid in euros and then convert it back to dollars using the exchange rates.

Interest paid in euros = Euro loan amount * interest rate = €1,000,000 * 5.50% = €55,000

To convert euros to dollars at the end of one year, we need to use the new exchange rate:

€1 = $1.45

Therefore, the interest paid in dollars = €55,000 * $1.45/€ = $79,750

The before-tax cost of capital is then:

Before-tax cost of capital = Total interest paid / Loan amount = $79,750 / $1,000,000 = 0.07975 or 7.975%

Rounding to the nearest whole percentage gives us an answer of 9%, which is closest to answer choice D, 9.27%.