3. M&M Lad is a US-based company manufacturing and selling premium quality kayaks in the US market M&M Ltd exports kayak to New Zealand and the United Kingdom. Currently, M&M Ltd has no exist ing business in New Zealand but is considering establishing a subsidiary there. M&M Ltd is due to receive 4,000,000 in 3 months time from a customer for the United Kingdom. The top management of the company is very much concern about the reported foreign exchange losses. The external finical environment has become highly volatile, the top management is intended to identify and implement strategies to mitigate the foreign exchange risk of the company. The following information has been by gathered by accounting staff related to the transactions stated above. Following information related to the money market has been given to you. Spot Rate: E/S 0.7422 3-month forward rate EIS 0.7731 Current interest rates: US prime 3.2%-3.8% per annum UK LIBOR 2.4% -2.7% per annum Following information related foreign has been given to you The initial investment required is 40 million in New Zealand dollars (NZS). Given the existing spot rate of s0.5 per New Zealand dollar, the initial investment in U.S. dollars is $ 20 million. In addition to the NZS 40 million initial investment for plant and equipment, NZS10 million is needed for working capital and will be borrowed by the subsidiary from a New Zealand bank, The New Zealand subsidiary will pay interest only on the loan cach year, at an interest rate of 12 per cent. The loan principal is to be paid in 3 years. In three years, the subsidiary is to be sold. M&M Led plans to settle the New Zealand loan by using the salvage value. The working capital will not be liquidated but will be used by the acquiring fim when it sells the subsidiary. M&M Ltd expects to receive NZ S28 million after subtracting capital gains taxes (Acquiring firm will not take the bank loan). Assume that this amount is not subject to a withholding tax. Forecast of demand for Kavak and other expenses. The project will be terminated at the end of Year 3 when the subsidiary will be sold. The price, demand, and variable cost of the product in New Zealand are as follows: Year Price Demand Variable Cost 1 NZS600 50,000 units NZS200 2 NZS??? ????? units NZS??? 3 NZS??? ????? units NZS??? The expected inflation in New Zeeland is 10%, hence the selling price of Kayak and variable cost will increase by 10% every year. (Year 2 and year 3). The demand for the product expected to increase by 20 % every year (Year 2 and year 3). The fixed costs, such as overhead expenses, are estimated to be NZS1,300,000 per year and assume it will not change due to inflation. The exchange rate of the New Zealand dollar is expected to be $0.45 at the end of Year 1,80.42 at the end of Year 2, and S0.40 at the end of Year 3. Tax policies of New Zealand government The New Zealand government will impose an income tax of 30% per cent on income. In addition, it will impose a withholding tax of 12% per cent on earnings remitted by the subsidiary. The U.S. government will allow a tax credit on the remitted earnings and will not impose any additional taxes. Other information All cash flows received by the subsidiary are to be sent to the parent at the end of each year. The subsidiary will use its working capital to support ongoing operations The plant and equipment are depreciated over 3 years using the straight-line depreciation method. Cost of the plant and machines was NZS40,000,000 and salvage value is NZ$28,000,000 M&M Ltd requires a 16% per cent rate of return on this project. Required a. M&M Ltd is due to receive 4,000,000 in 3 months time from a customer for the United Kingdom. Advice the management of M&M Ltd, the possible outcome of using the forward contract to mitigate the forex risk exposed in the above transaction using the information given about the money market. You may compare possible other methods available (excluding money market hedging) for mitigating the above Forex risk. (support your answer with calculations) (10 marks) b. M&M Ltd is due to receive 4,000,000 in 3 months' time from a customer for the United Kingdom. Advice the management of M&M Ltd, the possible outcome of using the money market to hedge the forex risk exposed in the above transaction using the information given about the money market. (support your answer with calculations) (10 marks) c. You are required to advise the management on taking up this project. (Top management keen to know the following aspects) NPV of the project Political Risk Characteristics and Financial Risk Characteristics M&M Ltd face in stating the business in New Zealand and application of Risk-adjusted discount rate. (30 marks) (End of the Paper) Present value of $1, that is (1+r) where r = interest rate; n = number of periods until payment or receipt Periods (n) 1 2 3 4 5 6 7 8 1% 0.990 0.980 0.971 0.961 0.951 0.942 0.933 0.923 0.914 0.905 0.896 0.887 0.879 0.870 0.861 0.853 0.844 0.836 0.828 0.820 10 11 12 13 14 15 16 17 18 19 20 2% 0.980 0.961 0.942 0.924 0.906 0.888 0.871 0.853 0.837 0.820 0.804 0.788 0.773 0.758 0.743 0.728 0.714 0.700 0.686 0.673 3% 0.971 0.943 0.915 0.888 0.863 0.837 0.813 0.789 0.766 0.744 0.722 0.701 0.681 0.661 0.642 0.623 0.605 0.587 0.570 0554 Interest rates a 5% 6% 0.952 0.943 0.907 0.890 0864 0.840 0.823 0.792 0.784 0.747 0.746 0705 0.711 0.665 0.677 0.627 0.645 0.592 0.614 0.558 0.585 0.527 0.557 0.497 0.530 0.469 0.505 0.442 0.481 0.417 0.458 0.394 0.438 0.371 0.416 0.350 0.396 0.331 0.377 0.312 4% 0.962 0.925 0.889 0.855 0.822 0.790 0.760 0.731 0.703 0.676 0.650 0.625 0.601 0.577 0.555 0.534 0.513 0.494 0.475 0.456 7% 0.935 0.873 0.816 0.763 0.713 0.666 0.623 0.582 0.544 0.508 0.475 0.444 0.415 0.388 0.362 0.339 0.317 0.296 0.277 0.258 8% 0.926 0.857 0.794 0.735 0.681 0.630 0.583 0.540 0.500 0.463 0.429 0.397 0.368 0.340 0.315 0.292 0.270 0.250 0.232 0.215 9% 0.917 0.842 0.772 0.708 0.650 0.596 0.547 0.502 0.460 0.422 0.388 0.356 0.326 0.299 0.275 0.252 0.231 0.212 0.194 0.178 10% 0.909 0.826 0.751 0.683 0.621 0.564 0.513 0.467 0.424 0.386 0.350 0.319 0.290 0.263 0.239 0.218 0.198 0.180 0.164 0.149 Periods 1 2 3 4 5 6 7 9 10 11 12 13 14 15 16 17 18 19 11% 0.901 0.812 0.731 0.659 0.593 0.535 0.482 0.434 0.391 0.352 0.317 0.286 0.258 0.232 0.209 0.188 0.170 0.153 0.138 0.124 12% 13% 0.893 0.885 0.797 0.783 0.712 0.693 0.636 0.613 0.567 0.543 0.507 0.480 0.452 0.425 0.404 0.376 0.361 0.333 0.322 0.295 0.287 0.261 0.257 0.231 0.229 0.204 0.205 0.181 0.183 0.160 0.163 0.141 0.146 0.125 0.130 0.111 0.116 0.098 0.104 0.087 14% 0.877 0.769 0.675 0.592 0.519 0.456 0.400 0.351 0.308 0.270 0.237 0.208 0.182 0.160 0.140 0.123 0.108 0.095 0.083 0.073 Interest rates 15% 16% 0.870 0.862 0.756 0.743 0.658 0.641 0.572 0.552 0.497 0.476 0.432 0.410 0.376 0.354 0.327 0.305 0.284 0.263 0.247 0.227 0.215 0.195 0.187 0.168 0.163 0.145 0.141 0.125 0.123 0.108 0.107 0.093 0.093 0.080 0.081 0.069 0.070 0.060 0.061 0.051 0.855 0.731 0.624 0.534 0.456 0.390 0.333 0.285 0.243 0.208 0.178 0.152 0.130 0.111 0.095 0.081 0.069 0.059 0.051 0.043 18% 0.847 0.718 0.609 0.516 0.437 0.370 0.314 0.266 0.225 0.191 0.162 0.137 0.116 0.099 0.084 0.071 0.060 0.051 0.043 0.037 19% 0.840 0.706 0.593 0.499 0.419 0.352 0.296 0.249 0.209 0.178 0.148 0.124 0.104 0.088 0.079 0.062 0.052 0.044 0.037 0.031 20% 0.833 0.694 0.579 0.482 0.402 0.335 0.279 0.233 0.194 0.162 0.135 0.112 0.093 0.078 0.065 0.054 0.045 0.038 0.031 0.026 Cumulative present value of $1 per annum, Receivable or Payable at the end of each year for years 2 3 210 2:51 5 379 20 7 72 73 8730 & 5. 90 650 000 1970 12 193 150633 1.730 2673 2004 2331 3902 3.60 3548 3312 3:4063 3.240 4715 & SNO RS 3.170 4452 43294212 2100 3900 330 5700 5.000 5.411 520 S.ORG 4201 4356 6230 8.002 52 500 5.035 40 7.000 400 62105 51 8500 8.162 100 Bests 8088350 947 8111 6.241 5.150 772273607004 710 48145 8780 3.3067887790 7.130.105 11286 10.590.354 0.00 8.86383547563 8814 12.154 15346 10.885 3.394 959.35 1.500 7:47 7100 13.004 12.100 1129 100 6733 12.07 118 118 100 1471 13.570 12:00 12:30 10.106 650 33 7894 15562 14.292 93.100 12.40 11274 1977 9.75 22 8. SA 3022 16.390 1400 13.754 12.650 11.690 0.003 059 8372 8.200 17220 54.324 13.14 92085 115 10:30 9.604 2.950 8.30 tR046 16.35114878 1350 11.00 1059129 9906 2100 16 17 Pro 1547 2.289 2:24 2 3 4 5 . 4:03 11 12 12 18% 0.901 0.870 20:1855 0.1347 1713 1090 166 1547 1808 1805 2.444 26 1500 2.22 2.74 3037 2140 100 2100 2014 2014 2.856 276 2600 26 250 2.00 3605 3.511 2001 3.754 2035 4712 4.564 4423 38 3410 2.328 4260 4.160 35023812 4 3.700 4 6.100 3.605 4207 LOT 3,954 5537 5329 3. 5132 4772 CAST S. 5.0 20 5019 20 5.30 5.61 6.450 6194 0918 5.000 4456 440 5421 5424 6.750 440 6122 4611 553 530 4910 4715 4513 6302 500 5.724 5229 500 62 5847 4611 5595 50 48762875 7379 6.974 6.6042 5954 5. 5.405 75497129 67298393 8047 51824930 4730 5 505 5222 4900 473 7.700 7250 6.840 6.00 5 553 5273 4812 2639 7366 8. 619 55 530 5070 4 7400 5.101 & 397 22 15 7100 18 20 3. M&M Lad is a US-based company manufacturing and selling premium quality kayaks in the US market M&M Ltd exports kayak to New Zealand and the United Kingdom. Currently, M&M Ltd has no exist ing business in New Zealand but is considering establishing a subsidiary there. M&M Ltd is due to receive 4,000,000 in 3 months time from a customer for the United Kingdom. The top management of the company is very much concern about the reported foreign exchange losses. The external finical environment has become highly volatile, the top management is intended to identify and implement strategies to mitigate the foreign exchange risk of the company. The following information has been by gathered by accounting staff related to the transactions stated above. Following information related to the money market has been given to you. Spot Rate: E/S 0.7422 3-month forward rate EIS 0.7731 Current interest rates: US prime 3.2%-3.8% per annum UK LIBOR 2.4% -2.7% per annum Following information related foreign has been given to you The initial investment required is 40 million in New Zealand dollars (NZS). Given the existing spot rate of s0.5 per New Zealand dollar, the initial investment in U.S. dollars is $ 20 million. In addition to the NZS 40 million initial investment for plant and equipment, NZS10 million is needed for working capital and will be borrowed by the subsidiary from a New Zealand bank, The New Zealand subsidiary will pay interest only on the loan cach year, at an interest rate of 12 per cent. The loan principal is to be paid in 3 years. In three years, the subsidiary is to be sold. M&M Led plans to settle the New Zealand loan by using the salvage value. The working capital will not be liquidated but will be used by the acquiring fim when it sells the subsidiary. M&M Ltd expects to receive NZ S28 million after subtracting capital gains taxes (Acquiring firm will not take the bank loan). Assume that this amount is not subject to a withholding tax. Forecast of demand for Kavak and other expenses. The project will be terminated at the end of Year 3 when the subsidiary will be sold. The price, demand, and variable cost of the product in New Zealand are as follows: Year Price Demand Variable Cost 1 NZS600 50,000 units NZS200 2 NZS??? ????? units NZS??? 3 NZS??? ????? units NZS??? The expected inflation in New Zeeland is 10%, hence the selling price of Kayak and variable cost will increase by 10% every year. (Year 2 and year 3). The demand for the product expected to increase by 20 % every year (Year 2 and year 3). The fixed costs, such as overhead expenses, are estimated to be NZS1,300,000 per year and assume it will not change due to inflation. The exchange rate of the New Zealand dollar is expected to be $0.45 at the end of Year 1,80.42 at the end of Year 2, and S0.40 at the end of Year 3. Tax policies of New Zealand government The New Zealand government will impose an income tax of 30% per cent on income. In addition, it will impose a withholding tax of 12% per cent on earnings remitted by the subsidiary. The U.S. government will allow a tax credit on the remitted earnings and will not impose any additional taxes. Other information All cash flows received by the subsidiary are to be sent to the parent at the end of each year. The subsidiary will use its working capital to support ongoing operations The plant and equipment are depreciated over 3 years using the straight-line depreciation method. Cost of the plant and machines was NZS40,000,000 and salvage value is NZ$28,000,000 M&M Ltd requires a 16% per cent rate of return on this project. Required a. M&M Ltd is due to receive 4,000,000 in 3 months time from a customer for the United Kingdom. Advice the management of M&M Ltd, the possible outcome of using the forward contract to mitigate the forex risk exposed in the above transaction using the information given about the money market. You may compare possible other methods available (excluding money market hedging) for mitigating the above Forex risk. (support your answer with calculations) (10 marks) b. M&M Ltd is due to receive 4,000,000 in 3 months' time from a customer for the United Kingdom. Advice the management of M&M Ltd, the possible outcome of using the money market to hedge the forex risk exposed in the above transaction using the information given about the money market. (support your answer with calculations) (10 marks) c. You are required to advise the management on taking up this project. (Top management keen to know the following aspects) NPV of the project Political Risk Characteristics and Financial Risk Characteristics M&M Ltd face in stating the business in New Zealand and application of Risk-adjusted discount rate. (30 marks) (End of the Paper) Present value of $1, that is (1+r) where r = interest rate; n = number of periods until payment or receipt Periods (n) 1 2 3 4 5 6 7 8 1% 0.990 0.980 0.971 0.961 0.951 0.942 0.933 0.923 0.914 0.905 0.896 0.887 0.879 0.870 0.861 0.853 0.844 0.836 0.828 0.820 10 11 12 13 14 15 16 17 18 19 20 2% 0.980 0.961 0.942 0.924 0.906 0.888 0.871 0.853 0.837 0.820 0.804 0.788 0.773 0.758 0.743 0.728 0.714 0.700 0.686 0.673 3% 0.971 0.943 0.915 0.888 0.863 0.837 0.813 0.789 0.766 0.744 0.722 0.701 0.681 0.661 0.642 0.623 0.605 0.587 0.570 0554 Interest rates a 5% 6% 0.952 0.943 0.907 0.890 0864 0.840 0.823 0.792 0.784 0.747 0.746 0705 0.711 0.665 0.677 0.627 0.645 0.592 0.614 0.558 0.585 0.527 0.557 0.497 0.530 0.469 0.505 0.442 0.481 0.417 0.458 0.394 0.438 0.371 0.416 0.350 0.396 0.331 0.377 0.312 4% 0.962 0.925 0.889 0.855 0.822 0.790 0.760 0.731 0.703 0.676 0.650 0.625 0.601 0.577 0.555 0.534 0.513 0.494 0.475 0.456 7% 0.935 0.873 0.816 0.763 0.713 0.666 0.623 0.582 0.544 0.508 0.475 0.444 0.415 0.388 0.362 0.339 0.317 0.296 0.277 0.258 8% 0.926 0.857 0.794 0.735 0.681 0.630 0.583 0.540 0.500 0.463 0.429 0.397 0.368 0.340 0.315 0.292 0.270 0.250 0.232 0.215 9% 0.917 0.842 0.772 0.708 0.650 0.596 0.547 0.502 0.460 0.422 0.388 0.356 0.326 0.299 0.275 0.252 0.231 0.212 0.194 0.178 10% 0.909 0.826 0.751 0.683 0.621 0.564 0.513 0.467 0.424 0.386 0.350 0.319 0.290 0.263 0.239 0.218 0.198 0.180 0.164 0.149 Periods 1 2 3 4 5 6 7 9 10 11 12 13 14 15 16 17 18 19 11% 0.901 0.812 0.731 0.659 0.593 0.535 0.482 0.434 0.391 0.352 0.317 0.286 0.258 0.232 0.209 0.188 0.170 0.153 0.138 0.124 12% 13% 0.893 0.885 0.797 0.783 0.712 0.693 0.636 0.613 0.567 0.543 0.507 0.480 0.452 0.425 0.404 0.376 0.361 0.333 0.322 0.295 0.287 0.261 0.257 0.231 0.229 0.204 0.205 0.181 0.183 0.160 0.163 0.141 0.146 0.125 0.130 0.111 0.116 0.098 0.104 0.087 14% 0.877 0.769 0.675 0.592 0.519 0.456 0.400 0.351 0.308 0.270 0.237 0.208 0.182 0.160 0.140 0.123 0.108 0.095 0.083 0.073 Interest rates 15% 16% 0.870 0.862 0.756 0.743 0.658 0.641 0.572 0.552 0.497 0.476 0.432 0.410 0.376 0.354 0.327 0.305 0.284 0.263 0.247 0.227 0.215 0.195 0.187 0.168 0.163 0.145 0.141 0.125 0.123 0.108 0.107 0.093 0.093 0.080 0.081 0.069 0.070 0.060 0.061 0.051 0.855 0.731 0.624 0.534 0.456 0.390 0.333 0.285 0.243 0.208 0.178 0.152 0.130 0.111 0.095 0.081 0.069 0.059 0.051 0.043 18% 0.847 0.718 0.609 0.516 0.437 0.370 0.314 0.266 0.225 0.191 0.162 0.137 0.116 0.099 0.084 0.071 0.060 0.051 0.043 0.037 19% 0.840 0.706 0.593 0.499 0.419 0.352 0.296 0.249 0.209 0.178 0.148 0.124 0.104 0.088 0.079 0.062 0.052 0.044 0.037 0.031 20% 0.833 0.694 0.579 0.482 0.402 0.335 0.279 0.233 0.194 0.162 0.135 0.112 0.093 0.078 0.065 0.054 0.045 0.038 0.031 0.026 Cumulative present value of $1 per annum, Receivable or Payable at the end of each year for years 2 3 210 2:51 5 379 20 7 72 73 8730 & 5. 90 650 000 1970 12 193 150633 1.730 2673 2004 2331 3902 3.60 3548 3312 3:4063 3.240 4715 & SNO RS 3.170 4452 43294212 2100 3900 330 5700 5.000 5.411 520 S.ORG 4201 4356 6230 8.002 52 500 5.035 40 7.000 400 62105 51 8500 8.162 100 Bests 8088350 947 8111 6.241 5.150 772273607004 710 48145 8780 3.3067887790 7.130.105 11286 10.590.354 0.00 8.86383547563 8814 12.154 15346 10.885 3.394 959.35 1.500 7:47 7100 13.004 12.100 1129 100 6733 12.07 118 118 100 1471 13.570 12:00 12:30 10.106 650 33 7894 15562 14.292 93.100 12.40 11274 1977 9.75 22 8. SA 3022 16.390 1400 13.754 12.650 11.690 0.003 059 8372 8.200 17220 54.324 13.14 92085 115 10:30 9.604 2.950 8.30 tR046 16.35114878 1350 11.00 1059129 9906 2100 16 17 Pro 1547 2.289 2:24 2 3 4 5 . 4:03 11 12 12 18% 0.901 0.870 20:1855 0.1347 1713 1090 166 1547 1808 1805 2.444 26 1500 2.22 2.74 3037 2140 100 2100 2014 2014 2.856 276 2600 26 250 2.00 3605 3.511 2001 3.754 2035 4712 4.564 4423 38 3410 2.328 4260 4.160 35023812 4 3.700 4 6.100 3.605 4207 LOT 3,954 5537 5329 3. 5132 4772 CAST S. 5.0 20 5019 20 5.30 5.61 6.450 6194 0918 5.000 4456 440 5421 5424 6.750 440 6122 4611 553 530 4910 4715 4513 6302 500 5.724 5229 500 62 5847 4611 5595 50 48762875 7379 6.974 6.6042 5954 5. 5.405 75497129 67298393 8047 51824930 4730 5 505 5222 4900 473 7.700 7250 6.840 6.00 5 553 5273 4812 2639 7366 8. 619 55 530 5070 4 7400 5.101 & 397 22 15 7100 18 20
