Use the Information for the Question(s) Below

Use the information for the question(s) below.
The current spot exchange rate, S, is $1.8862/£. Suppose that the yield curve in both countries is flat. The risk-free rate on dollars, r_$, is 5.35% and the risk-free interest rate on pounds, r_£, is 4.80%.
-Luther Industries, a U.S. firm, is considering an investment in Japan. The dollar cost of equity for Luther is 12%. The risk-free interest rates on dollars and yen are r_$ = 5.5% and r_¥ = 1.5%, respectively. Luther Industries is willing to assume that capital markets are internationally integrated. Luther Industries needs to know the comparable cost of equity in Japanese yen for a project with free cash flows that are uncorrelated with spot exchange rates. The yen cost of equity for Luther Industries is closest to ________.

A) 14.0%
B) 12.3%
C) 7.8%
D) 18.5%

Correct Answer:

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