What are the risks involved in making the decision

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Reference no: EM133908919

Problem

As ToyCar is looking to expand, the company will need to borrow £30m to fund this expansion. Interest on the £30m would be paid at the end of each of the following five years. The principal sum of £30m would be repaid in full at the end of the 5-year loan period.

Normally ToyCar only borrows in UK Sterling (GBP). However, ToyCar's board believes that borrowing in Euros (EUR) or US Dollars (USD) should be considered as it may be cheaper on this occasion and ask their Treasurer to investigate. She provides the Board with the following details.

The interest rates on the loan for each currency would be:

1) GBP 12% p.a.
2) USD 10% p.a. (Current exchange rate GBP 1 = USD 1.3)
3) EUR 15% p.a. (Current exchange rate GBP 1 = EUR 1.1)

The Treasurer forecasts that, over the five years, USD will appreciate 2% per annum against GBP. She forecasts that the EUR will depreciate by 5% per annum against GBP.

Note: these are percentage changes in the exchange rates. So, for example, if in Year 1 the EUR does depreciate by 5% against GBP the exchange rate will, at the end of the year, be GBP 1 = EUR 1.1 x 1.05 = 1.155.

If borrowing in a foreign currency ToyCar would have to buy the amounts of USD or EUR needed at the end of each year to pay the interest on the loan and to repay the principal sum at the end of Year 5. Get the instant assignment help.

Note that the Treasurer's exchange rate forecasts do not match those currently prevailing in the financial markets.

ToyCar's earnings are almost entirely in UK Sterling (GBP).

Task

1) Based on the information provided by the Treasurer, which currency would be the cheapest for ToyCar to borrow in?
2) What are the risks involved in making this decision on the borrowing of the £30m required?

Reference no: EM133908919

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