Please contact me on: elenaoxford@yahoo.co.uk Thank you, Elena Coursework 1 The management of
Please contact me on: elenaoxford@yahoo.co.uk
Thank you,
Elena
Coursework
1
The management of your company, which is based in the UK, intend to pursue a globalisation agenda. They are unsure whether to license local companies, takeover an existing company or set up a completely new company in the USA.
Prepare a report explaining the inherent risks your company should consider before licensing, acquisition or Greenfield investment. Data is available on the websites listed below and you should identify relevant data and produce relevant graphs and tables to include in your report. You must explain the relevance of the data and graphs you have included in your report and provide an overall recommendation as to whether your company should license local companies, takeover an existing company or set up a completely new company in the USA.
You will need to provide information concerning:
The advantages and disadvantages of licensing local companies, taking over an existing company or setting up a completely new company.
Provide a discussion of the following and relate your discussion to each of the three strategies the company is considering:
An example of transaction exposure using historical exchange rates, but also explain the possible effects of translation and economic exposure.
The report should be 600 words long.
2
Music plc is a multinational company which produces musical instruments and exports them worldwide and has a number of licence agreements with various overseas companies allowing them to produce instruments under the Music plc brand name.
Didgeredoo Pty Ltd, an Australian company, has recently purchased equipment from Music plc for £5,000,000. The currency risk of this purchase is of particular concern to Didgeredoo Pty Ltd and the payment is due in 6 months time. The following data has been compiled:
Spot exchange rate £0.671/AU$ Forward rate (3 months) £0.65/AU$
UK borrowing rate 5.00% p.a. UK investment rate 4.00% p.a.
Australian borrowing rate 5.5% p.a. Australian investment rate 5.00% p.a.
£ Call option exercise price £0.68/AU$ Premium 1.5% of £ notional
Required:
Identify and calculate the costs of the alternative strategies available for hedging this risk and advise which strategy would have produced the best outcome for Didgeredoo Pty Ltd, assuming the actual spot rate in 3 months time is £0.68/AU$.
Explain why economic (operating) exposure might be of concern to Music plc even though they do not, at the moment, have any foreign direct investment (FDI).
Describe the additional operating exposures Music plc would be exposed to if they were to engage in FDI and describe the strategies the company might undertake to reduce its level of economic exposure.
Explain why translation exposure might be of concern to multinational organisations and briefly describe how a multinational organisation might reduce its exposure to translation risk.
3
Several of the companies which hold a licence from Music plc are based in Latin America but there is concern that Music plc might be losing customers due to a lack of a physical presence in Latin America. As the Latin American market is very important, Music plc is considering three possible strategies
A joint venture with a Brazilian company Music plc currently licenses.
An acquisition of a Brazilian company Music plc currently licenses.
Setting up new production facilities in Brazil.
Required:
Describe the advantages and disadvantages of the above strategies.
Explain the relevance of the following risks to Music plc potentially arising from foreign direct investment and explain how Music plc might reduce these risks:
Firm-specific risk
Country specific risk
4
Music plc is considering the potential impact on its financial policy of acquiring a Brazilian company. Music plc’s capital structure is currently 50% equity, 50% debt but the Brazilian company’s capital structure is 30% equity, 70% debt. Music plc is considering paying for the acquisition with shares in Music plc rather than cash and would like to pay the Brazilian management partly in stock options.
Required
Describe the components of the weighted average cost of capital and discuss whether Music plc should retain their existing leverage ratio or move towards a localised leverage ratio.
Explain the potential benefits of borrowing in Brazil rather than the UK following the acquisition.
Explain the potential benefits to Music plc of listing their stock on the Brazilian stock exchange.
5
Music plc has estimated the potential cash flows from a joint venture with a Brazilian company which would last for three years. The estimated cash flows for the project are given below and management consider that a discount rate of 12% reflects the riskiness of the venture.
| Year 0 | Year 1 | Year 2 | Year 3 | |
| Total cash inflows (Brazilian real (m)) | 0 | 120 | 130 | 90 |
| Total cash outflows (Brazilian real (m)) | 100 | 80 | 90 | 40 |
| Additional £ cash inflows | 0 | 30 | 30 | 30 |
| Forecast exchange rate (£/R$) | 0.36 | 0.36 | 0.37 | 0.37 |
Required
Calculate the net present value of the investment for Music plc.
An alternative to the joint venture would be to set up a subsidiary in Brazil to handle the project. Explain whether such a project undertaken by a subsidiary should be considered from the subsidiary’s perspective or Music plc’s perspective. Discuss the additional factors which need to be considered if Music plc’s perspective is taken.
As an alternative to setting up a subsidiary now, Music plc could choose to proceed with the joint venture and then decide whether to set up a subsidiary in three years’ time if the market is favourable. Discuss why the opportunity to defer investment might be valuable for a company and why real option analysis is superior to discounted cash flow techniques in such situations.
6
Music plc is concerned that the may be restrictions in repatriating funds from Brazil if a subsidiary is set up.
Required:
Describe and evaluate the different methods Music plc could use to repatriate funds to the UK.
Music plc is considering the price to charge for one of the components that it produces in the UK and will ship to Brazil for further processing. The UK tax rate is currently 25%, whereas the Brazilian tax rate for the subsidiary would be 20%. Using an exchange rate of R$0.36/£ calculate the total tax payable in £’s if the transfer price is either £3.00 per unit or £4.00 per unit. If Music plc wishes to minimise global taxes which transfer price should it use?
Explain what is meant by the arm’s length rule with respect to transfer pricing and why governments may insist that multinational organisations use it.
Music plc is considering the cash balance the subsidiary should hold in Brazil.
Briefly describe the transaction motive and the precautionary motive for holding cash.
Briefly explain what is meant by the cash conversion cycle.
7
Aveskot, a Japanese manufacturer of computer chips, exports chips to companies in both the Eurozone and the US.
Aveskot has just billed a major computer manufacturer in the US and the customer insisted that the invoice be in dollars rather than yen. The invoice is payable in 3 months time but Aveskot is concerned that the dollar to yen exchange rate might adversely change and has asked you to explain how Aveskot might hedge the risk. The invoice is for $20 million.
Currently, the spot exchange rate is ¥80/$ and the three-month forward rate is ¥81/$.
The Japanese investment rate is 3 percent per annum and the Japanese borrowing rate is 5.2 percent per annum.
The US investment rate is 2.4 percent per annum and the US borrowing rate is 4.8 percent per annum.
The Put option, on dollars, exercise price is ¥84/$ and the premium is 1.5% of Yen, notional.
Required
Calculate the receipt, in Yen, if the spot rate in 3 months time is ¥83/$ and advise whether (i) choosing not to hedge; (ii) a forward contract; (iii) a money market hedge, or (iv) an option contract would have been the best choice, in retrospect.
Briefly discuss why some multinational companies may choose not to hedge.
Explain the differences between translation exposure and economic exposure and suggest strategies that a multinational company might adopt to reduce these types of exposure.
