Lluvia Manufacturing and Paraguas Products Assignment Help With Solution
1.Lluvia and Paraguas.Lluvia Manufacturing and Paraguas Products both seek funding at the lowest possible cost. Lluvia would prefer the flexibility of float ingrate borrowing, while Paraguas wants the security of fixed rate borrowing. Lluvia is the more creditworthycompany. They face the following rate structure. Lluvia, with the better credit rating, has lower borrowing costs in both types of borrowing. Lluvia wants floating-rate debt, so it could borrow at LIBOR + 1%. However, it could borrow fixed at 8% and swap for floating-rate debt. Paraguas wants fixed rate debt, so it could borrow fixed at 12%. However, it could borrow floating at LIBOR + 2% and swap for fixed rate debt. What should they do?
2.Your firm needs to raise $100 million in funds. You can borrow short term at a spread of 1% over LIBOR. Alternatively, you can issue 10-year, fixed-rate bonds at a spread of 2.50% over 10-year Treasuries, which currently yield 7.60%. Current 10-year interest rate swaps are quoted at the LIBOR rate versus the 8% fixed rate.
Management believes that the firm is currently “underrated” and that its credit rating is likely to improve in the next year or two. Nevertheless, the managers are not comfortable with the interest rate risk associated with using short-term debt.
a.Suggest a strategy for borrowing the $100 million. What is your effective borrowing rate?
b.Suppose the firm’s credit rating does improve three years later. It can now borrow at a spread of 0.50% over Treasuries, which now yield 9.10% for a seven-year maturity. Also, seven-year interest rate swaps are quoted at LIBOR versus 9.50%. How would you lock in your new credit quality for the next seven years? What is your effective borrowing rate now?
3.Calculate the required rate of return for Manning Enterprises, assuming that investors expect a 3.4% rate of inflation in the future. The real risk-free rate is 2.00% and the market risk premium is 6.0%. Manning has a beta of 2.4, and its realized rate of return has averaged 11.5% over the last 5 years. Round your answer to two decimal places.
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4.Explain both interest rate swaps and currency swaps. Which instrument has a greater credit risk: an interest rate swap or a currency swap? How can multinational companies utilize a currency swap to reduce borrowing costs? If you expect short-term interest rates to rise more than the yield curve suggests, would you rather pay a fixed long-term rate and receive a floating short-term rate, or receive a fixed long-term rate and pay a floating short-term rate?
5.HR Industries (HRI) has a beta of 2.1, while LR Industries’ beta is 0.8. The risk-free rate is 6%, and the required rate of return on an average stock is 13%. Now the expected rate of inflation built into rRF falls by 1.5 percentage points, the real risk-free rate remains constant, the required return on the market falls to 10.5%, and all betas remain constant. After all of these changes, what will be the difference in the required returns for HRI and LRI? Round your answer to two decimal places.
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