Use the information for the question(s) below.
The current spot exchange rate, S, is $1.8862/£. Suppose that the yield curve in both countries is flat. The risk-free rate on dollars, r_$, is 5.35% and the risk-free interest rate on pounds, r_£, is 4.80%.
-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%

Use the Information for the Question(s) Below