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Case

Chapter Two

Case 5

Remain unhedged amount in yen expected spot rate cost after 2 months Buy one futures contract amount in yen futures price per yen cost after 2 months Buy two options amount in yen exercise price premium per yen

## 12,500,000 0.006912 86,400

12,500,000 0.006912 86,400 Option 1 Option 2 6,250,000 6,250,000 0.00756 0.00792 0.0001512 0.0001134 2 x Option 1 2 x Option 2 Options 1 & 2 1,417.50 1653.75 86,400 86,400 87,817.50 88,053.75

Total premium in yen exercise price cost after 2 months Question 6 Remain unhedged amount in yen expected spot rate cost after 2 months Buy one futures contract amount in yen futures price per yen cost after 2 months Buy two options amount in yen exercise price premium per yen

## 0.006912 0.0005 0.007912

12,500,000 0.006912 86,400 Option 1 Option 2 6,250,000 6,250,000 0.00756 0.00792 0.0001512 0.0001134 2 x Option 1 2 x Option 2 Options 1 & 2

## 1653.75 96,700 98,353.75

1. The inflation-exchange relationship can be found in the PPP theory. The theory suggests that the currency of the country with the higher inflation rate should depreciate to compensate the inflation differential. High levels of inflation in Thailand should cause baht to depreciate since it is a freely floating currency. Because of the export deal Blades has struck, it is unable to alter its prices so they go in line with the level of inflation. Therefore Blades revenue would be negatively affected. Blades costs will increase as Thai exporters adjust their prices to inflation. Blades exports are baht-denominated thus baht depreciation will lead to a conversion of baht into fewer dollars. However, according to the PPP the baht depreciation should counter high levels of inflation therefore creating an impact on the high prices. The net effect of this relationship on Blades is negative. 2. Factors that prevent PPP from occurring in the short run are: relative interest rates, government regulations, national income, lack of proper substitute products, etc. The reason being is that the exchange rates are impacted by factors other than the inflation. PPP will not hold if countries negotiate trade arrangements under which they commit themselves to the purchase or sale of a fixed number of goods over a specified period of time. At lest it will not hold in the short run. The logic behind

this statement is that there will be a setback on the impact of inflation, and thus the exchange rates because of the committed trade arrangements that are not easily terminated due to the legal power of a contract.

1. There are several ways Blades can benefit. Blades generates baht-denominated cash inflows and then converts them to U.S. dollars. Forecasting the exchange rate may allow Blades to make hedging decisions. Furthermore, it is mentioned that Blades may establish a subsidiary in Thailand. If this was to happen, profits earned by this subsidiary will be in baht. These earnings will then be sent back to the parent or reinvested in Thailand. In both scenarios forecasting exchange rate is vital for companys future. 2. A market-based forecast is the easiest to use because it is based on either spot rate or the forward rate. In this case it would be better to use forward rates. 3. The forward rates would yield a better market-based forecast. It is said that the available forward rates currently exhibit a large discount, which implies higher interest rate, which then implies higher inflation. Higher inflation is associated with a downward pressure on the baht, which is a valid forecast. Using the present spot rate to forecast future spot rate would mean that the value of the baht would not fluctuate, which is not likely to happen. 4. market-based forecast By using the forward rate market-based forecast it is shown that baht is expected to change by -8.70 percent. The value of the baht in 90 days according to this forecast will

-0.08696 be \$0.021. 5. Weekly accuracy of technical forecast indicates market inefficiency for the baht-dollar exchange rates. Technical forecasting involves the use of historical exchange rate data to predict future rates and mostly apply to very shot-term periods such as one day. Given the conditions Thailand is in, examination of past movements will not be useful for indicating future rates. 6. fundamental forecast The expected change using the fundamental forecast is -6.85 percent. -0.0685 forecasted value of the baht The forecasted value of the baht using the expected value as the forecast is \$.0214. absolute error- technical forecasting absolute error- fundamental forecasting absolute error- market-based forecasting 0.021425 -0.01727 -0.02614 -0.04545 The absolute forecast errors are as follows: technical forecasting 1.73%; fundamental forecasting 2.61%; and the market-based forecast 4.54%. Observing given forecasting techniques and their absolute errors the conclusion arises that the most accurate technique is the technical forecasting. 7. It will not. As mentioned earlier, technical forecasting involves the use of historical

exchange rate data to predict future rates. Examination of past movements will most likely not be as useful for indicating future rates in Thailand. There are a lot of uncertainties when it comes to exchange rates in this country. There is a high volatility of the baht-dollar exchange rate. In addition, Thai economy is experiencing unfavorable conditions that will have an affect on exchange rates.

1. Blades is subject to transaction and economic exposure. Transaction exposure is the exposure of an organizations contractual transactions to exchange rate movements. Economic exposure is any exposure of a companys cash flows to exchange rate movements. 2. See attached spreadsheet. 3. It will reduce Blades transaction exposure. The reason being is that if the dollar revenue is decreased due to baht depreciation, the dollar cost will also decrease due to the depreciation of yen (Blades generates baht-denominated net inflows, but its outflows are yen-denominated). 4. I dont think it should. Blades only way of reducing its net transaction exposure lies in importing from Japan due to the high correlation level between baht and yen. It is less likely that the correlation between these two currencies will last for the extended period of time. The correlation has been low in the past and will most likely return to its normal state in the future.

5. The transaction exposure will have a slight increase. In this scenario two factors impact transaction exposure. Firstly, Blades net cash inflows would be denominated in foreign currencies driving the transaction exposure upwards. Secondly, the correlation between baht and yen on one side, and British pound on the other, is not significantly high. This means that changes in one currency (BP) may not drastically affect the other (baht).

Currency inflow British pound 16,000,000 Japanese yen Thai baht 826,920,000

## expected exchange rate 1.5 0.0083 0.024

Currency

net inflow-outflow

British pound 16,000,000 Japanese yen 12,648,000 Thai baht 620,208,000 Blades, Inc. Case 11 1.

## range in U.S. \$ from 23,520,000.00 99,919.20 12,404,160.00

baht baht Forward Hedge Revenue Forward rate Dollars to be received (90 days) Money Market Hedge Ammount borrowed (baht) Dollars from converting baht Dollars accumulated (90 days) 152,730,000 0.0215 3,283,695

## Outflow (90 days) Net inflow (outflow)

54,000,000 152,730,000

## 146,855,769 3,377,683 3,448,614

Stay Unhedged Probability Spot rate 5% 20 30 25 15 5 Dollars from converting baht 0.2000 3,054,600 0.0213 3,253,149 0.0217 3,314,241 0.0220 3,360,060 0.0230 3,512,790 0.0235 3,589,155

## The best option would be to use the money market hedge.

2.

BP BP BP Forward Hedge Revenue Forward rate Dollars to be received (90 days) Money Market Hedge Ammount borrowed (BP) Dollars from converting BP Dollars accumulated (90 days) Stay Unhedged Probability 4,000,000 1.49 5,960,000

## Inflow (90 days) Outflow (90 days) Net inflow (outflow)

4,000,000 4,000,000

## 3,921,569 5,882,353 6,005,882

Spot rate Dollars from converting baht 5% 1.4500 5,800,000 20 1.4700 5,880,000 30 1.4800 5,920,000 25 1.4900 5,960,000 15 1.5000 6,000,000 5 1.5200 6,080,000

has a policy of paying Thai imports upon a day of delivery in order to maintain a good

allowed period. Any currency changes in this period could affect Blades. The tradeoff

would be that Blades will not be able to use baht-denominated costs to balance its baht-

denominated revenues.

7. Given all the conditions, Blades could benefit from long-term forward contracts for

both baht and BP, agree to a parallel loan, or swap currencies. The reason being is that

long-term hedging is possible for companies that can estimate their foreign currency

Case 12

## 1. Blades would be negatively affected in several ways. Firstly, if the commitment is

renewed the agreed prices would be fixed. In addition, high level of inflation would

cause baht to depreciate, thus decreasing the dollars gained from baht-denominated

sales. Finally, the costs of goods sold in Thailand would be negatively impacted by the

2. With the current conditions it is less likely that Thai importer will renew its commitment.

The reason being - negative economical effects. With the high inflation and possibility

of baht depreciating, Thai customers will be less willing to spend money on leisure

products. However, if the economy returns to the high growth level, Thai importer will

more likely want to renew the deal. The importer will be confident in the future sales.

3. 0.022 1.53 62,400,000 18,192,240 24,480,000 105,072,240 0.0209 1.485 62,400,000 17,282,628 23,760,000 103,442,628 0.0198baht 1.5BP 62,400,000 16,373,016 24,000,000 102,773,016

Sales U.S. Thai British Total Cost U.S. Thai Total Expenses U.S. Fixed U.S. Variable Total CF before taxes

## 2,000,002 6,864,000 8,864,002 31,757,014

Blades doesnt seam to be impacted much by the high level of economic exposure. 4. 0.022 0.0209 0.0198baht 1.5 1.425 1.35BP 62,400,000 62,400,000 62,400,000 18,192,240 17,282,628 16,373,016 24,000,000 22,800,000 21,600,000 104,592,240 102,482,628 100,373,016

Sales U.S. Thai British Total Cost U.S. Thai Total Expenses

## 2,000,000 6,864,000 8,864,000 29,357,016

Here we can see that if baht and BP are perfectly correlated Blades would be exposed to

increasing level of economic risk. The main reason is that Blades generates its inflows in

both currencies. A depreciation of both currencies would have a more significant affect on Blades cash flows before taxes.

5. Blades can choose to do several things to reduce its level of economic exposure to

## Thailand. One option would be to diversify the selection of countries to do business

with. By incorporating countries that have insignificant correlation to each other, Blades

reduces its economic exposure. Furthermore, Blades can engage in buying supplies in

Thailand, thus creating more cash outflows in baht. Blades could borrow in baht, pay off

baht-denominated loans, and convert baht to dollars to pay U.S. supplies. Finally, Blades

could borrow in baht, pay off baht-denominated loans, and convert baht to dollars to pay

U.S. supplies.

Case 13

1. Given the current situation, there are several things that would factor in a positive

DFI. Firstly, Blades generates higher profit margin in Thailand. In addition, the cost of

materials is significantly cheaper in Thailand. DFI in Thailand would diversify the risk.

In other words, Blades would not be solely reliant on the U.S. economic conditions.

## Finally, Blades would increase its overall market share.

2. The main tradeoff is between the initial outlay required to invest and operating under

uncertain economic conditions. If Blades was to engage in DFI now, the initial outlay

will be low. However, the primary concern is that Thai consumers have not been affected

yet by the unfavorable economic conditions, and the possibility that the economic

conditions will not improve in the future. If this was to happen, Blades would pay a price.

Nevertheless, If Blades waits one year and economy improves, the initial outlay required

would be high, and there is a change there might be heavier competition. As a financial

consultant for Blades, I would advise a scenario analysis, as well as the series of other

financial analysis (applying various ratios, etc.) prior to making this decision. Scenario

analysis would be useful because we can see the possible outcomes and the changes

for worst, best, and average situation. We could go from there. Based on the current

situation, however, I would advise Ben Holt to wait with the DFI.

3. Again the main tradeoff is profits versus the risk of poor economic conditions. If Blades

renews the agreement with the retailer for another 3 years, it will tie itself to relatively

low prices it charges the Thai retailer. If economic conditions improve, there would be an expected increase in the demand for Blades products. Blades would generate higher

profit margins if decided to enter the market through the subsidiary, or construct a more

favorable deal with another retailer. On the other hand, if economic conditions continue

to worsen, the agreement would be profitable for Blades. Again I believe that a set of

## financial analysis are needed prior to making this decision.

4. Given all the conditions mentioned, Thai government would have to consider the impact

## of Blades subsidiary on the employment, as well as the impact of Blades subsidiary

the unemployment rate if they were to commit to employ local workers. However,

Thai government should be concerned about the local businesses. In the long run,

companies like Blades could run Thai competitors out of business, thus increasing the

unemployment even more. In reality, it all depends on the government policy to allow foreign investments. I believe that Thai government would most likely welcome MNCs

subsidiaries in order to deal with the unemployment in a short run. Another promising

## solution would be possible mergers and acquisitions.

Case 14

1. In the given scenario, sales from the existing agreement should not be included in the

capital budgeting analysis. The reason being is that Blades would have these sales with

or without the subsidiary in Thailand. The cost savings for the pairs not sourced from

Thailand should be included because these sales would not happen if Blades continued

to import from Thailand. Finally, the sales resulting from a renewed agreement should be

included in the capital budgeting analysis because this revenue is incremental to creating

2. See spreadsheet. Blades should establish the subsidiary in Thailand under the given

conditions. The capital budgeting analysis shows a positive NPV if Blades renews the

## agreement with Entertainment Products and establishes the subsidiary

3. See spreadsheet. The capital budgeting analysis indicates that Blades should establish a

subsidiary and not renew its agreement. The NPV was \$8,746,688

4. See spreadsheet. The salvage value is not that critical. The capital budgeting analysis in

question 2 is the most feasible alternative. As spreadsheet suggests (comparing question 3 and question 4), even if Blades salvage value is reduced to 0 (Blades does not sell the

## subsidiary), the NPV remains positive.

5. See spreadsheet. The capital budgeting analysis shows a positive NPV of \$5,620,315 for

the worst case scenario. Therefore, Blades should establish the subsidiary even if baht

## depreciates by 5 percent annually.

Capital Budgeting Analysis PROBLEM # 2 Demand - Entertainment Products Price per unit - baht Revenue from agreement Other retailers Price per unit - baht Revenue from other retailers Total revenue Variable cost per unit Total variable cost

Year 0

Year 1

Year 2

Year 3

Year 4

## 0 120,000 5,000 600,000,000 600,000,000 3,500 420,000,000

180,000 180,000 180,00 4,594 4,594 4,59 826,920,000 826,920,000 826,920,00 120,000 220,000 220,00 5,600 6,272 7,02 672,000,000 1,379,840,000 1,545,420,80 1,498,920,000 2,206,760,000 2,372,340,80 3,920 4,390 4,91 1,176,000,000 1,756,160,000 1,966,899,20

Less: cost savings Other fixed expenses Depreciation Total expenses EBT of susidiary Host government tax (25%) After tax earnings of subsidiary NCF to subsidiary Baht remitted by susidiary Witholding tax on remitted funds (10%) Baht remitted after witholding taxes Salvage value Exchange rate - baht CF to parent PV of parent CF (25% discount rate) Initial investment by parent Cumulative PV

32,400,000 25,000,000 30,000,000 442,600,000 157,400,000 39,350,000 118,050,000 148,050,000 148,050,000 14,805,000 133,245,000 0.02300 0.02254 3,003,342 2,402,674 -10,247,326

28,000,000 31,360,000 35,123,20 30,000,000 30,000,000 30,000,00 1,234,000,000 1,817,520,000 2,032,022,40 264,920,000 389,240,000 340,318,40 66,230,000 97,310,000 85,079,60 198,690,000 291,930,000 255,238,80 228,690,000 321,930,000 285,238,80 228,690,000 321,930,000 285,238,80 22,869,000 205,821,000 0.02209 4,546,421 2,909,710 -7,337,617 32,193,000 289,737,000 0.02165 6,272,057 3,211,293 -4,126,323

28,523,88

256,714,92

## 0.0212 5,446,07 2,230,71

12,650,000

-1,895,61

PROBLEM # 3 Demand - Entertainment Products Price per unit - baht Revenue from agreement Other retailers Price per unit - baht Revenue from other retailers Total revenue Variable cost per unit Total variable cost Less: cost savings Other fixed expenses Depreciation Total expenses EBT of susidiary Host government tax (25%) After tax earnings of subsidiary NCF to subsidiary Baht remitted by susidiary Witholding tax on remitted funds (10%) Baht remitted after witholding taxes Salvage value

Year 0

Year 1

Year 2

Year 3

Year 4

0 120,000 5,000 600,000,000 600,000,000 3,500 420,000,000 32,400,000 25,000,000 30,000,000 442,600,000 157,400,000 39,350,000 118,050,000 148,050,000 148,050,000 14,805,000 133,245,000

5,000 5,000 5,00 5,600 6,272 7,02 28,000,000 31,360,000 35,123,20 120,000 220,000 220,00 5,600 6,272 7,02 672,000,000 1,379,840,000 1,545,420,80 700,000,000 1,411,200,000 1,580,544,00 3,920 4,390 4,91 490,000,000 987,840,000 1,106,380,80

28,000,000 31,360,000 35,123,20 30,000,000 30,000,000 30,000,00 548,000,000 1,049,200,000 1,171,504,00 152,000,000 362,000,000 409,040,00 38,000,000 90,500,000 102,260,00 114,000,000 271,500,000 306,780,00 144,000,000 301,500,000 336,780,00 144,000,000 301,500,000 336,780,00 14,400,000 129,600,000 30,150,000 271,350,000

33,678,00

303,102,00

Exchange rate - baht CF to parent PV of parent CF (25% discount rate) Initial investment by parent Cumulative PV

0.02300

## 0.0212 6,430,14 2,633,78

12,650,000

-2,773,87

PROBLEM # 4 Demand - Entertainment Products Price per unit - baht Revenue from agreement Other retailers Price per unit - baht Revenue from other retailers Total revenue Variable cost per unit Total variable cost Less: cost savings Other fixed expenses Depreciation Total expenses EBT of susidiary Host government tax (25%) After tax earnings of subsidiary NCF to subsidiary Baht remitted by susidiary Witholding tax on remitted funds (10%) Baht remitted after witholding taxes Salvage value Exchange rate - baht CF to parent PV of parent CF (25% discount rate) Initial investment by parent Cumulative PV

Year 0

Year 1

Year 2

Year 3

Year 4

0 120,000 5,000 600,000,000 600,000,000 3,500 420,000,000 32,400,000 25,000,000 30,000,000 442,600,000 157,400,000 39,350,000 118,050,000 148,050,000 148,050,000 14,805,000 133,245,000 0.02300 0.02254 3,003,342 2,402,674 -10,247,326

5,000 5,000 5,00 5,600 6,272 7,02 28,000,000 31,360,000 35,123,20 120,000 220,000 220,00 5,600 6,272 7,02 672,000,000 1,379,840,000 1,545,420,80 700,000,000 1,411,200,000 1,580,544,00 3,920 4,390 4,91 490,000,000 987,840,000 1,106,380,80

28,000,000 31,360,000 35,123,20 30,000,000 30,000,000 30,000,00 548,000,000 1,049,200,000 1,171,504,00 152,000,000 362,000,000 409,040,00 38,000,000 90,500,000 102,260,00 114,000,000 271,500,000 306,780,00 144,000,000 301,500,000 336,780,00 144,000,000 301,500,000 336,780,00 14,400,000 129,600,000 0.02209 2,862,760 1,832,167 -8,415,160 30,150,000 271,350,000 0.02165 5,874,026 3,007,501 -5,407,658

33,678,00

303,102,00

## 0.0212 6,430,14 2,633,78

12,650,000

-2,773,87

PROBLEM # 5 Demand - Entertainment Products Price per unit - baht Revenue from agreement Other retailers Price per unit - baht

Year 0

Year 1

Year 4

0 120,000 5,000

## 5,00 7,02 35,123,20 220,00 7,02

Revenue from other retailers Total revenue Variable cost per unit Total variable cost Less: cost savings Other fixed expenses Depreciation Total expenses EBT of susidiary Host government tax (25%) After tax earnings of subsidiary NCF to subsidiary Baht remitted by susidiary Witholding tax on remitted funds (10%) Baht remitted after witholding taxes Salvage value Exchange rate - baht CF to parent PV of parent CF (25% discount rate) Initial investment by parent Cumulative PV

600,000,000 600,000,000 3,500 420,000,000 32,400,000 25,000,000 30,000,000 442,600,000 157,400,000 39,350,000 118,050,000 148,050,000 148,050,000 14,805,000 133,245,000 0.02300 0.02185 2,911,403 2,329,123 -10,320,877

672,000,000 1,379,840,000 1,545,420,80 700,000,000 1,411,200,000 1,580,544,00 3,920 4,390 4,91 490,000,000 987,840,000 1,106,380,80

28,000,000 31,360,000 35,123,20 30,000,000 30,000,000 30,000,00 548,000,000 1,049,200,000 1,171,504,00 152,000,000 362,000,000 409,040,00 38,000,000 90,500,000 102,260,00 114,000,000 271,500,000 306,780,00 144,000,000 301,500,000 336,780,00 144,000,000 301,500,000 336,780,00 14,400,000 129,600,000 0.02076 2,690,172 1,721,710 -8,599,167 30,150,000 271,350,000 0.01972 5,350,920 2,739,671 -5,859,496

33,678,00

303,102,00

12,650,000

-3,533,70

Case 15

## 1. See spreadsheet. Blades should choose to establish a subsidiary in Thailand. The

NPV with acquisition would be \$6,641,949. The NVP without the acquisition results

## \$8,746,668. Therefore, \$8,746,668 - \$6,641,949 = \$2,104,739.

2. See spreadsheet. Blades should reduce the purchase price by \$2,104,739 / \$0.023 =

## \$91,510,391. Therefore, the maximum amount Blades should be willing to pay is

\$1,000,000,000 - \$91,510,391 = \$908,489,609 baht. 3. Blades should consider several factors. The price asked for the SkatesnStuff is lower

in comparison to the capital budget analysis. Blades should find out why the company is

being sold for that price. In addition, Blades should also look into the acquisition of an

existing business in Thailand. Getting to know the local market is essential. Moreover,

the information I was provided with may be inaccurate. If that is the case the capital

## budgeting analysis would be inaccurate. Another important factor is the quality of

roller blades and the production process. The lower quality roller blades produced by SkatersnStuff may jeopardize Blades reputation. Finally, there might be issues with

management if the acquisition happens. Blades would have to make sure that the right people are on the bus. This may lead to a mass layoff.

## Capital Budgeting Analysis

Year 0

Year 1

Year 2

Year 3

Year 4

Demand - retailers

280,000

280,000

280,000

280,000

Price per unit - baht 4,500 Revenue from retailers 1,260,000,000 Total revenue 1,260,000,000 Variable cost per unit 3,500 Total variable cost 980,000,000 Less: cost savings 32,400,000 Other fixed expenses 20,000,000 Depreciation 60,000,000 Total expenses 1,027,600,000 EBT of susidiary 232,400,000 Host government tax (25%) 58,100,000 After tax earnings of subsidiary 174,300,000 NCF to subsidiary 234,300,000 Baht remitted by susidiary 234,300,000 Witholding tax on remitted funds (10%) 23,430,000 Baht remitted after witholding taxes 210,870,000 Salvage value Exchange rate - baht 0.02300 CF to parent 4,850,010 PV of parent CF (25% discount rate) 4,850,010 Initial investment by parent 23,000,000 Cumulative PV -18,149,990

5,040 1,411,200,000 1,411,200,000 3,920 1,097,600,000 32,400,000 22,400,000 60,000,000 1,147,600,000 263,600,000 65,900,000 197,700,000 257,700,000 257,700,000 25,770,000 231,930,000 0.02254 5,227,702 4,182,162 -13,967,828

5,645 1,580,544,000 1,580,544,000 4,390 1,229,312,000 25,088,000 60,000,000 1,314,400,000 266,144,000 66,536,000 199,608,000 259,608,000 259,608,000 25,960,800 233,647,200 0.02209 5,161,080 3,303,091 -10,664,737

6,322 1,770,209,280 1,770,209,280 4,917 1,376,829,440 28,098,560 60,000,000 1,464,928,000 305,281,280 76,320,320 228,960,960 288,960,960 288,960,960 28,896,096 260,064,864 0.02165 5,629,732 2,882,423 -7,782,314

1,982,6 1,982,6

1,542,0

31,4 60,0 1,633,5 349,1 87,2 261,8 321,8 321,8 32,1 289,6

0 6,1 2,5

-5,2