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Chapter 5: Q13DQ (page 680)

What is LIBOR? How does it compare to the U.S. prime rate?

Short Answer

Expert verified

LIBOR is a reference or bench mark rate used to borrow or lend funds in the London wholesale money market or inter-bank lending market.

LIBOR is comparatively less than that of the U.S. Prime rate.

Step by step solution

01

LIBOR stands for London interbank offered rate

It is the most widely used bench mark interest rate all over world. It is calculated every day by Intercontinental Exchange and published by Reuters around 11:30 am.

02

Comparing LIBOR with the U.S. Prime rate

U.S. Prime rate is the rate upon which large banks gives loan to their most creditworthy clients. The current U.S. prime rate is 4.75%.

  • Libor rate fluctuates continually whereas US Prime rate is a fixed rate, which remain unchanged for a period of time.
  • Libor is used by banks whereas US Prime rate is used by consumers.
  • Libor rate is less than that of the U.S. Prime rate.

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Most popular questions from this chapter

What procedures would you recommend for a multinational company in studying exposure to political risk? What actual strategies can be used to guard against such risk?

The Office Automation Corporation is considering a foreign investment. The initial cash outlay will be \(10 million. The current foreign exchange rate is 2 ugans 5 \)1. Thus the investment in foreign currency will be 20 million ugans. The assets have a useful life of five years and no expected salvage value. The firm uses a straight-line method of depreciation. Sales are expected to be 20 million ugans and operating cash expenses 10 million ugans every year for five years. The foreign income tax rate is 25 percent. The foreign subsidiary will repatriate all aftertax profits to Office Automation in the form of dividends. Furthermore, the depreciation cash flows (equal to each year’s depreciation) will be repatriated during the same year they accrue to the foreign subsidiary. The applicable cost of capital that reflects the riskiness of the cash flows is 16 percent. The U.S. tax rate is 40 percent of foreign earnings before taxes.

  1. Should the Office Automation Corporation undertake the investment if the foreign exchange rate is expected to remain constant during the five year period?
  2. Should Office Automation undertake the investment if the foreign exchange rate is expected to be as follows?

Year 0 .......................... \(152.0ugans

Year 1 .......................... \)152.2ugans

Year 2 .......................... \(152.4ugans

Year 3 .......................... \)152.7ugans

Year 4 .......................... \(152.9ugans

Year 5 .......................... \)1 5 3.2 ugans

Differentiate between the spot exchange rate and the forward exchange rate.

The Clark Corporation desires to expand. It is considering a cash purchase of Kent Enterprises for \(3 million. Kent has a \)700,000 tax loss carryforward that could be used immediately by the Clark Corporation, which is paying taxes at the rate of 30 percent. Kent will provide $420,000 per year in cash flow (aftertax income plus depreciation) for the next 20 years. If the Clark Corporation has a cost of capital of 13 percent, should the merger be undertaken?

J & J Enterprises is considering a cash acquisition of Patterson Steel Company for \(4,500,000. Patterson will provide the following pattern of cash inflows and synergistic benefits for the next 20 years. There is no tax loss carryforward.

Years 1–5 6–15 16–20 Cash inflow (aftertax) ...................... \)490,000 \(650,000 \)850,000 Synergistic benefits (aftertax) ......... 45,000 65,000 75,000

The cost of capital for the acquiring firm is 12 percent. Compute the net present value. Should the merger be undertaken? (If you have difficulty with deferred time value of money problems, consult Chapter 9.)
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