Airline Borrowing Case: May 1985


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 (Â¥).  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.”


If the loan is in U. S. Dollars in the USA, company policy requires the use of a specific investment banker.  This firm describes the terms of the USA loan as follows:  A coupon 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 0.5% (of the amount borrowed) to be paid when the loan 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 Â¥ to the $ as the exchange rate in May 1985.  Each student must recommend the best alternative and discuss why it is best.


Your solution should consist of three parts:


First, create a schedule showing the interest, principal payments, and fees due for the dollar-denominated loan. 


Second, for the yen-denominated loan, create a schedule showing the interest and principal payments due (in yen).  Then, right underneath, create another schedule showing those same interest and principal payments in dollars, under any assumption about the yen-dollar exchange-rate during the term of the loan.  If you’ve done this second schedule correctly, you should be able to plug in 250 Â¥ to the $, for instance, and see the second schedule update automatically.


Third, use the tool you’ve just developed to find the exchange rate at which the two loans have the same NPV.  To keep things simple, you may assume that U.S. interest rates remain at 11% and Japanese interest rates remain at 5% for the term of the loans in your NPV calculation.


Based on the information available in May 1985, which loan alternative is best and why?


  • Analyses and conclusion are only as good as the data and assumptions that they are based on. 
  • If your analysis contains data and/or assumptions unsupported by reasoning and explanations plus sources of the related data, a reader has no basis to accept your presentation as valid.
  • Without proper support the reader is likely to disregard your analysis and/or conclusions, and may even begin to have some doubts about you.
  • So ALWAYS support all of your numbers or calculations with reasoning, explanations and sources for all of your data.
  • All answers should be placed in a single Excel file,  

"Is this question part of your assignment? We can help"