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Advanced Corporate Finance

Background information:

From the given information, it is noted that Exacta, s. a., a foremost manufacturer of precision machine tools located in Lyons, is aiming to set up a local manufacturing plant in the United States. The organization has a greater part of its sales within the European Union.

However, it is also noted that almost two-thirds of Exacta’s output is exported to the United States. The management team of Exacta, s.a., accepts that the level of sales in the United States is huge and sufficient to have a local manufacturing unit.

Further, it is also expected that in future it will also support the organizationto expand its business activities across the market place in Canada and Mexico.

Under such circumstances, the financial director, M. Pangloss, along with other members of the management team, is keen on this new venture.

The given information notes that the initial investment for establishing the manufacturing plant in South Carolina is $380 million.

There is a huge opportunity for success, but at the same time, there are some concerns and anxieties about the risks associated with international business expansion.

Taken for consideration, the CEO, M. B. Bardot, has articulatedworriedaboutprobablerelated to currency or exchange rate.

The given information suggests that M. Pangloss has tried to restore the CEO’s confidence by saying that the risk related to currency is nothing new for the organization. He also assured that the organization is efficient enough to deal with such risk related to currency.

This may be true, as the organization is currently exporting machine tools each year to the U.S., worth approximately $320 million.

To do so, the organization never evidenced any significant losses due to exchange rate risks of its dollar revenue in Euros.

Given information has also explored the fact that the organization currently exercises a two-month credit period for payments for its exported goods. So, this indicates that about one-sixth of the money[$320 million, as previously mentioned] is currently exposed to currency risk at any point in time.

Further, it is also evidenced that M. Pangloss is confident that if any risk related to currency or exchange rate exists, the organization is sufficient to hedge itself against this by issuing bonds.

Therefore, it can be said that such initiatives mightcounterbalance the investment amount in terms of dollarwith the help of a corresponding dollar liability.

In this context, the given information also indicates that there is another alternative for the organization. It says the organization can sell a forward contract for the expected revenue of $420 million before proceeding with this project.

Now, it is true that, as the financial director, M. Pangloss is aware that he has the responsibility to assess cautiously the risk related to the exchange rate that might arise due to such an investment.

From the given information, it is also noted that there is an opportunity to earn a potential profit of $52 million per year. This would not require any kind of extra investment during operation.

Exacta can evidence a significant benefit: such expansion in the U.S. market will enhance the organization’s international existence.

So, it can be said that being the financial manger, M. Pangloss requires to investigate any contingentissues from investment in the U.S. with the help of examining itsfactualas well asexisting exposure and decide which particular approach of hedging will be the most effectualalong withreasonably priced.

Statement of the problem:

  1. What would Exacta’s true exposure be from its new U.S. operations, and how would it change from the company’s current exposure?
  2. Given that exposure, what would be the most effective and inexpensive approach to hedging?

Potential options for management review:

There are two options available for management review such as –

Option 1: The investment of $ 380 million for the establishment of this new plant in South Carolina can be done through issuing U. S. dollar bonds to counterbalance the investment amount in terms of dollarwith the help of a corresponding dollar liability;

Option 2: The organization can sell forward contract of the expected revenue of $420 million prior to proceed with this project.

Essential financial information:

Here, the essential information that will support to conclude is as follows:

  • Total investment amount for new plant in the U.S. [South Carolina] is $ 380 million;
  • Expected annual revenue from this operation will be $ 420 million;
  • Expected annual net profit from this operation will be $ 52 million;
  • The organization already exporting $ 320 million per year with no such significant loss related to currency or exchange risk;
  • As per the CEO, M. B. Bardot, normally risk-averse, the investment amount of $380 million could grounds for significant amount of lossesdue to the fact that the is a chance for depreciation in the dollar value in against to the euro;
  • The revenue earned from the new plant in South Carolina will be in U. S. dollar;
  • The 2 / 3 of the operating cost for the new plant in South Carolina will be in U. S. dollar;
  • The 1 / 3 of the operating cost for the new plant in South Carolinawould be from apparatusfetched in from Lyons along with the head office’s charge for managementservices as well as use of patents;
  • No decision has been taken yet whether to use U.S. dollar or euro for the head office’s charge for patents;

Analysis:

Table 1: US $ per Euro

  Spot Rate Fwd Rate
1 Month 3 Months 1 Year
Euro 1.4201 1.4201 1.42 1.4207

The above table represents the exchange rate of the US dollar with the Euro. It can be said that in one month, the euro will be worth the same as it is now.

This indicates that the Euro is holding its value till one month(Berk & DeMarzo, 2007). The table also shows that in three months, the Euro will have gone down the value and in one year, the euro will have gone up in value.

Therefore, it indicates that, while in three months, more Euros are required to buy $1, in one year, the opposite will be true, that is, less Euros will be required to buy $1.

Table 2: Exacta Currency Risk

Description U.S. $ – now Euro – now Euro – 1 month Euro – 3months Euro – 1 year
Investment  $    380,000,000.00  €     267,586,789.66  €     267,586,789.66  €     267,605,633.80  €     267,473,780.53
Annual revenues  $    420,000,000.00  €     295,753,820.15  €     295,753,820.15  €     295,774,647.89  €     295,628,915.32
Net Profits  $       52,000,000.00  €        36,617,139.64  €        36,617,139.64  €        36,619,718.31  €        36,601,675.23
2/3 Op Costs  $    245,333,333.33  €     172,757,787.01  €     172,757,787.01  €     172,769,953.05  €     172,684,826.73
1/3 Op Costs  $    122,666,666.67  €        86,378,893.51  €        86,378,893.51  €        86,384,976.53  €        86,342,413.36

*U.S. dollar price = euro price in France / # Euros per dollar

*Euro price = $ price in U.S. / # $ per euro

(Bos, Mahieu & Dijk, 2001; Campbell, Medeiros & Viceira, 2007)

The above table provides details of the two investment strategies along with their currency risk exposure in terms of spot rate, 1 month forward rate, 3 months forward rate, and 1 year forward rate.

Now, from the above table it is noted that if the organization aims to sell forward expected revenue, then, it will evidenced gain of € 295,753,820.15 – € 295,628,915.32 = € 124,904.83

Now, since the payment is received within two months of purchase, only 1 / 6 th of the money will be at risk.

So, the amount of money that will be in risk is € 124,904.83 * (1 / 6) = € 20817.47

Here, the changes in the value of dollar = (1.4207-1.4201)/1.4201

= 0.000422505

Conclusion and recommendations:

It is apparent that the organization, Exacta s. a. is more affluent to invoice its U.S. operation in Euros related to the purchasing activities with the parent organization for the reason that the value of the Euro is appreciating over the 1 year time frame during operation (Campbell, Medeiros & Viceira, 2007).

The finding also indicates that while the payment is made, it will be comparatively beneficial for the organization than if the payment is made in dollars(Chen & Yu, 2011;Moran, 2010).

Here, the prior reason to conclude this is that the operation in the U.S. will have to turn up with a comparatively lesser amount of Euros during the completion of the one-year period in comparison to the strategy to have U.S. $.

[a] The calculation evidences that Exacta s. a. experienced transaction exposure due to its new operation in the U.S.

The transaction exposure takes place because of the delays of 2 months in payments in terms of foreign currency transaction.

In this context, it is noted that M. Pangloss can estimate Exacta’s current exposure to risk related to currency with consideringone-sixth of its annual sales of $320 million, which would provide a total amount of $53.33 million.

Now, this $53.33 million is the amount of Exacta’s “probable losses or gains on its foreign operations in consequence of exchange rate fluctuations” (“exchange rate exposure”, 2006). On the other hand, Exacta’s true exposure from its new U.S. operations would be $174.67 million.

This is estimated by combining the net profit and operating expenses. If the organization took a loan in U.S. dollars to fund the investment of $380 million, this would be the case.

Here, such a decision will be taken because U.S. revenues would be employed to compensate the interest on the debt, and net income would be the solitary component returning to France, over and above both the cost related to management fees and patents.

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Background information:

From the given information, it is noted that Exacta, s. a., a foremost manufacturer of precision machine tools located in Lyons, is aiming to set up a local manufacturing plant in the United States. The organization has a greater part of its sales within the European Union.

However, it is also noted that almost two-thirds of Exacta’s output is exported to the United States. The management team of Exacta, s.a., accepts that the level of sales in the United States is huge and sufficient to have a local manufacturing unit.

Further, it is also expected that in future it will also support the organizationto expand its business activities across the market place in Canada and Mexico.

Under such circumstances, the financial director, M. Pangloss, along with other members of the management team, is keen on this new venture.

It is noted from the given information that the initial investment for establishing the manufacturing plant in South Carolina is $380 million. There is a huge opportunity for success, but at the same time, there are some concerns and anxieties about the risks associated with international business expansion.

Taken into consideration, the CEO, M. B. Bardot, has articulated concerns about probable risks related to currency or exchange rates. The given information suggests that M. Pangloss has tried to restore the CEO’s confidence by saying the risk related to currency is nothing new for the organization.

He also assured that the organization is efficient enough to deal with such risk related to currency. This may be true as the organization is currently exporting machine tools each year to the U.S., worth approximately $320 million.

To do so, the organization never evidenced any significant losses due to exchange rate risks of its dollar revenue in Euros.

Given information has also explored the fact that the organization currently exercises a two-month credit period for payments for its exported goods. So, this indicates that about one-sixth of the money[$320 million, as previously mentioned] is currently exposed to currency risk at any point in time.

Further, it is also evidenced that M. Pangloss is confident that if any risk related to currency or exchange rate exists, the organization is sufficient to hedge itself against this by issuing bonds.

Therefore, it can be said that such initiatives mightcounterbalance the investment amount in terms of dollarwith the help of a corresponding dollar liability.

In this context, the given information also indicates that there is another alternative for the organization. It says the organization can sell a forward contract for the expected revenue of $420 million before proceeding with this project.

Now, it is true that, as the financial director, M. Pangloss is aware that he has the responsibility to assess cautiously the risk related to the exchange rate that might arise due to such an investment.

From the given information, it is also noted that there is an opportunity to earn a potential profit of $52 million per year. This would not require any kind of extra investment during operation.

Exacta can evidence a significant benefit: such expansion in the U.S. market will enhance the organization’s international existence.

So, it can be said that being the financial manger, M. Pangloss requires to investigate any contingentissues from investment in the U.S. with the help of examining itsfactualas well asexisting exposure and decide which particular approach of hedging will be the most effectualalong withreasonably priced.

Statement of the problem:

  1. What would Exacta’s true exposure be from its new U.S. operations, and how would it change from the company’s current exposure?
  2. Given that exposure, what would be the most effective and inexpensive approach to hedging?

Potential options for management review:

There are two options available for management review such as –

Option 1: The investment of $ 380 million for the establishment of this new plant in South Carolina can be done through issuing U. S. dollar bonds to counterbalance the investment amount in terms of dollarwith the help of a corresponding dollar liability;

Option 2: The organization can sell forward contract of the expected revenue of $420 million prior to proceed with this project.

Essential financial information:

Here, the essential information that will support to conclude is as follows:

  • Total investment amount for new plant in the U.S. [South Carolina] is $ 380 million;
  • Expected annual revenue from this operation will be $ 420 million;
  • Expected annual net profit from this operation will be $ 52 million;
  • The organization already exporting $ 320 million per year with no such significant loss related to currency or exchange risk;
  • As per the CEO, M. B. Bardot, normally risk-averse, the investment amount of $380 million could grounds for significant amount of lossesdue to the fact that the is a chance for depreciation in the dollar value in against to the euro;
  • The revenue earned from the new plant in South Carolina will be in U. S. dollar;
  • The 2 / 3 of the operating cost for the new plant in South Carolina will be in U. S. dollar;
  • The 1 / 3 of the operating cost for the new plant in South Carolinawould be from apparatusfetched in from Lyons along with the head office’s charge for managementservices as well as use of patents;
  • No decision has been taken yet whether to use U.S. dollar or euro for the head office’s charge for patents;

Analysis:

Table 1: US $ per Euro

  Spot Rate Fwd Rate
1 Month 3 Months 1 Year
Euro 1.4201 1.4201 1.42 1.4207

The above table represents the exchange rate of US dollar with Euro. From the above table, it can be said that in one month, the euro will be worth same as it is now. This indicates that the Euro is holding its value till one month(Berk & DeMarzo, 2007).

The table also shows that in three months, the Euro will have decreased in value, and in one year, it will have increased in value. Therefore, it indicates that, while in three months, more euros are required to buy $1, in one year, the opposite will be true, that is, less euros will be required to buy $1.

Table 2: Exacta Currency Risk

Description U.S. $ – now Euro – now Euro – 1 month Euro – 3months Euro – 1 year
Investment  $    380,000,000.00  €     267,586,789.66  €     267,586,789.66  €     267,605,633.80  €     267,473,780.53
Annual revenues  $    420,000,000.00  €     295,753,820.15  €     295,753,820.15  €     295,774,647.89  €     295,628,915.32
Net Profits  $       52,000,000.00  €        36,617,139.64  €        36,617,139.64  €        36,619,718.31  €        36,601,675.23
2/3 Op Costs  $    245,333,333.33  €     172,757,787.01  €     172,757,787.01  €     172,769,953.05  €     172,684,826.73
1/3 Op Costs  $    122,666,666.67  €        86,378,893.51  €        86,378,893.51  €        86,384,976.53  €        86,342,413.36

*U.S. dollar price = euro price in France / # Euros per dollar

*Euro price = $ price in U.S. / # $ per euro

(Bos, Mahieu & Dijk, 2001; Campbell, Medeiros & Viceira, 2007)

The above table provides details of the two investment strategies along with their currency risk exposure in terms of spot rate, 1 month forward rate, 3 months forward rate, and 1 year forward rate.

Now, from the above table it is noted that if the organization aims to sell forward expected revenue, then, it will evidenced gain of € 295,753,820.15 – € 295,628,915.32 = € 124,904.83

Now, since, the payment is received within two months of purchase, only 1 / 6 th of the money will be at risk.

So, the amount of money that will be in risk is € 124,904.83 * (1 / 6) = € 20817.47

Here, the changes in the value of dollar = (1.4207-1.4201)/1.4201

= 0.000422505

Conclusion and recommendations:

It is apparent that the organization, Exacta s. a. is more affluent to invoice its U.S. operation in Euros related to the purchasing activities with the parent organization for the reason that the value of the Euro is appreciating over the 1 year time frame during operation (Campbell, Medeiros & Viceira, 2007).

The finding also indicates that while the payment is made, it will be comparatively beneficial for the organization than if the payment is made in dollars(Chen & Yu, 2011;Moran, 2010).

Here, the prior reason to conclude this is that the operation in the U.S. will have to turn up with a comparatively lesser amount of Euros during the completion of the one-year period in comparison to the strategy to have U.S. $.

[a] It is evidenced from the calculation that due to such new operation in the U. S., the organization, Exacta s. a. experience the transaction exposure. The transaction exposure takes place because of the delays of 2 months in payments in terms of foreign currency transaction.

In this context, it is noted that M. Pangloss can estimate Exacta’s current exposure to risk related to currency with consideringone-sixth of its annual sales of $320 million, which would provide a total amount of $53.33 million.  Now, this $53.33 million is the amount of Exacta’s “probable losses or gains on its foreign operations in consequence of exchange rate fluctuations” (“exchange rate exposure”, 2006).

On the other hand, Exacta’s true exposure from its new U.S. operations would be $174.67 million. This is estimated by combining net profit and operating expenses. If the organization took a loan in U.S. dollars to fund the investment amount of $380 million, this would be the case.

Here, such decision will be takenfor the reason that U.S. revenues would be employed to compensate the interest on the debt, as well as net income would be the solitarycomponent retuning to France, over and aboveboth the cost related to management fees as well as patents.

To get assignment help, please contact to our live chat adviser.