IBM is considering having its German affiliate issue a 10-year, $100 million bond denominated in euros and priced to yield 4%. Alternatively, IBMâ€™s German unit can issue a dollar-denominated bond of the same size and maturity and carrying an interest rate of 2.7%.
a. If the euro is forecast to depreciate by 1.7% annually, what is the expected dollar cost of the euro-denominated bond? How does this compare to the cost of the dollar bond?
b. At what rate of euro depreciation will the dollar cost of the euro-denominated bond equal the dollar cost of the dollar-denominated bond?
c. Suppose IBMâ€™s German unit faces a 35% corporate tax rate. What is the expected after-tax dollar cost of the euro-denominated bond?