Zigto Co is a medium-sized company whose ordinary shares are all owned by the members of one family. It has recently begun exporting to a European country and expects to receive €500,000 in six months’ time. The prospect of increased exports to the European country means that Zigto Co needs to expand its existing business operations in order to be able to meet future orders.

All of the family members are in favour of the planned expansion, but none are in a position to provide additional finance. The company is therefore seeking to raise external finance of approximately $1 million. At the same time, the company plans to take action to hedge the exchange rate risk arising from its European exports.

Zigto Co could put cash on deposit in the European country at an annual interest rate of 3% per year, and borrow at 5% per year. The company could put cash on deposit in its home country at an annual interest rate of 4% per year, and borrow at 6% per year. Inflation in the European country is 3% per year, while inflation in the home country of Zigto Co is 4·5% per year.

The following exchange rates are currently available to Zigto Co:

Current spot exchange rate 2·000 euro per $
Six-month forward exchange rate 1·990 euro per $
One-year forward exchange rate 1·981 euro per $

Required:

Discuss the factors that Zigto Co should consider when choosing a source of debt finance and the factors that may be considered by providers of finance in deciding how much to lend to the company.