Exercise 10: Reducing Country Risk

Explain some methods of reducing exposure to existing country risk, while maintaining the same
amount of business within a particular country.

Algunos métodos revisados en el capítulo son los siguientes:

 Contratar mano de obra local

 Utilizar un horizonte a corto plazo
 Pedir prestados fondos locales
 Crear un conjunto de empresas
 Obtener un seguro

Exercise 14: Country Risk Ratings

Assauer Inc. would like to assess the country risk of Glovanskia. Assauer has identified various
political and financial risk factors, as shown below. Assauer has assigned an overall rating of 80
percent to political risk factors and of 20 percent to financial risk factors. Assauer is not willing to
consider Glovanskia for investment if the country risk rating is below 4.0. Should Assauer consider
Glovanskia for investment?

Political Risk Factor Assigned Rating Assigned Weight

Blockage of found
transfers 5 40%

Bureaucracy 3 60%

Financial Risk Factor Assigned Rating Assigned Weight

Interest rate 1 10%

Inflation 4 20%

Exchange rate 5 30%

Competition 4 20%

Growth 5 20%

El rating sería el siguiente:

Rating de riesgo politico = ( 5∗40 % ) + ( 3∗60 % ) =3.8

Rating de riesgo financiero¿ ( 1∗10 % ) + ( 4∗20 % )+ ( 5∗30 % ) + ( 4∗20 % )=4.2

Ratig total¿ ( 3.8∗80 % )+ ( 4.2∗20 % ) =3.88

Como el rating de riesgo es menor a 4, Assauer probablemente no considere realizar su inversión.

Exercise 24: Accounting for Country Risk of a Project

Kansas Co. wants to invest in a project in China. It would require an initial investment of 5 million
yuan. It is expected to generate cash flows of 7 million yuan at the end of one year. The spot rate of
the yuan is $.12, and Kansas thinks this exchange rate is the best forecast of the future. However,
there are two forms of country risk.

First, there is a 30 percent chance that the Chinese government will require that the yuan cash flows
earned by Kansas at the end of one year be reinvested in China for one year before they can be
remitted (so that cash would not be remitted until two years from today). In this case, Kansas would
earn 4 percent after taxes on a bank deposit in China during that second year. Second, there is a 40
percent chance that the Chinese government will impose a special remittance tax of 400,000 yuan at
the time that Kansas Co. remits cash flows earned in China back to the United States.

The two forms of country risk are independent. The required rate of return on this project is 26
percent. There is no salvage value. What is the expected value of the project’s net present value?

Posible ganancia Probabilidad de que Posible tasa Probabilidad de que

sobre depósito ocurra el evento impositiva ocurra el evento
4% 30% 400000.00 40%
0% 70% 0.00 60%
100% 100%

Ganancias sobre Retención de

Escenario
depósito impuesto
1 4% 40000
2 0% 40000
3 4% 0
4 0% 0

Se realizó el flujo de caja de cada escenario con la TMAR del 26% y la tasa de cambio de $0.12,
para calcular el valor presente neto (VAN) del proyecto.
 Ganancias sobre Retención de Probabilidad
Escenario VAN
depósito impuesto conjunta
1 4% 40000 $83,900.23 12.00%
2 0% 40000 $62,857.14 28.00%
3 40% 0 $87,830.69 18.00%
4 60% 0 $66,666.67 42.00%

4
E ( VAN )=∑ VA N i∗pi =$ 71,477.55
i=1

Exercise 9. Financing Decision

Veer Co. is a U.S.-based MNC that has most of its operations in Japan. Since the Japanese
companies with which it competes use more financial leverage, it has decided to adjust its financial
leverage to be in line with theirs. With this heavy emphasis on debt, Veer should reap more tax
advantages. It believes that the market’s perception of its risk will remain unchanged, since its
financial leverage will still be no higher than that of its Japanese competitors. Comment on this
strategy

Las compañías en Japón tienen la capacidad de emplear un nivel más elevado de apalancamiento
financiero gracias a sus vínculos con los prestamistas y el gobierno. Existe la posibilidad de que el
gobierno japonés intervenga para respaldar a una empresa del país si sus acciones son propiedad de
inversores o instituciones locales. En contraste, es poco probable que brinde ayuda a una subsidiaria
de una empresa estadounidense. Esta subsidiaria japonesa carece del mismo grado de salvaguardias
que otras empresas japonesas. En consecuencia, si esta filial intenta emplear un exceso de
apalancamiento financiero, enfrentará un riesgo mayor en comparación con sus contrapartes
japonesas.

Exercise 23. Financing with Foreign Equity

Orlando Co. has its U.S. business funded in dollars with a capital structure of 60 percent
debt and 40 percent equity. It has its Thailand business funded in Thai baht with a capital
structure of 50 percent debt and 50 percent equity. The corporate tax rate on U.S. earnings
and on Thailand earnings is 30 percent. The annualized 10-year risk-free interest rate is 6
percent in the United States and 21 percent in Thailand. The annual real rate of interest is
about 2 percent in the United States and 2 percent in Thailand. Interest rate parity exists.
Orlando pays 3 percentage points above the risk-free rates when it borrows, so its before-
tax cost of debt is 9 percent in the United States and 24 percent in Thailand. Orlando
expects that the U.S. stock market return will be 10 percent per year and expects that the
Thailand stock market return will be 28 percent per year. Its business in the United States
has a beta of.8 relative to the U.S. market, while its business in Thailand has a beta of 1.1
relative to the Thai market. The equity used to support Orlando’s Thai business was created
from retained earnings by the Thailand subsidiary in previous years. However, Orlando Co.
is considering a stock offering in Thailand that is denominated in Thai baht and targeted at
Thai investors.

Estimate Orlando’s cost of equity in Thailand that would result from issuing stock in
Thailand.

R f (Thailand )=21%

Rm ( Thailand )=28 %

β (Thailand )=1.1

K p=R f + β (R m−R f )+ Spread

K p=21% +1.1 ( 28 %−21 % )

K p=28.70 %

Exercise 25. Sensitivity of Foreign Project Risk to Capital

Structure Texas Co. produces drugs and plans to acquire a subsidiary in Poland. This
subsidiary is a lab that would perform biotech research. Texas Co. is attracted to the lab
because of the cheap wages of scientists in Poland. The parent of Texas Co. would review
the lab research findings of the subsidiary in Poland when deciding which drugs to produce
and would then produce the drugs in the United States. The expenses incurred in Poland
will represent about half of the total expenses incurred by Texas Co. All drugs produced by
Texas Co. are sold in the United States, and this situation would not change in the future.
Texas Co. has considered three ways to finance the acquisition of the Polish subsidiary if it
buys it. First, it could use 50 percent equity funding (in dollars) from the parent and 50
percent borrowed funds in dollars. Second, it could use 50 percent equity funding (in
dollars) from the parent and 50 percent borrowed funds in Polish zloty. Third, it could use
50 percent equity funding by selling new stock to Polish investors denominated in Polish
zloty and 50 percent borrowed funds denominated in Polish zloty.

Assuming that Texas Co. decides to acquire the Polish subsidiary, which financing
method for the Polish subsidiary would minimize the exposure of Texas to exchange
rate risk? Explain.

Esta empresa está expuesta a las fluctuaciones de tipo de cambio, por lo tanto, si el tipo de
cambio en Polonia es volátil, es decir, si el zloty polaco varía con bastante frecuencia es
mejor escoger la primera opción, en donde se financia el 50% con fondos de la matriz y el
otro 50% con préstamo en dólar estadounidense. Dado que la constante variación, afectaría
el pago de intereses de un préstamo pedido en Polonia. Sin embargo, si el riesgo cambiario
no es tan alto, se recomienda la segunda opción, en donde se financia tanto con la matriz
como con un préstamo en zloty polaco, sabiendo que la moneda polaca está depreciada con
respecto al dólar, con un tipo de cambio de $0.25, lo cual podría beneficiar el pago del
préstamo de la multinacional.