Luther Industries, an Australian 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

To find the yen cost of equity, we need to use the following formula: 
Re¥ = (Re$ - r$) + r¥

Re$ = 12% 
r$ = 5.5% 
r¥ = 1.5%

Therefore, Re¥ = (12% - 5.5%) + 1.5% = 7.8%

The closest answer choice is B) 7.8%.

Luther Industries, an Australian Firm, Is Considering an Investment in Japan