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It is May 1985 and UAL, Inc., parent of United Airlines, needs to borrow $500 million to finance the purchase of Hertz. You are Assistant Treasurer and must make a recommendation about the choice between borrowing in the USA in U. S. Dollars or in Japan in Yen (¥). As background, UAL, Inc. owns United Airlines and Westin Hotels. It is buying Hertz from RCA. United Airlines will generate about 80% of the UAL revenue and the remainder will be evenly split between Hertz and Westin. United Airlines, Hertz, and Westin Hotels are worldwide service companies that generate revenue in many countries and currencies, mainly in the U.S., Canada, Latin America, and Europe. The Treasurer considers this to be a “No Brainer” or easy choice.
If the loan is in U. S. Dollars in the USA, company policy requires the use of a specific investment banker. This firm estimates terms of the USA loan as follows: An interest rate of 11% per year paid semi-annually in December and June for 10 years. The principal of $500 million would be repaid at the end of the 10-years. There would be a one-time underwriting fee of approximately 0.5% to be paid when the funds are received.
A leading Japanese bank is offering a loan with the interest and principal denominated in Yen. The interest rate will be 5% and there are no upfront fees. Both loans require interest payments in December and in June. The entire principal is due in June 1995.
In May 1985, the exchange rate fluctuated between 250 and 252 yen to the dollar. For convenience, use 250 ¥ to the $ as the exchange rate.
Instructions: As an assistant treasurer at that time, you are required to make a recommendation specifying which alternative of the two is better; (b) explain and discuss why your alternative is wise.
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