Decorative Designs

Decorative Designs (DD) is a family-owned furniture manufacturing company in Vietnam established in January 2015. The CEO of the company met a financial consultant recently to obtain some financial advice to decide whether to enter the international markets. The purpose of this meeting is to discuss the new export order the DD has received from a US company. The new order is to export 100 wooden garden dining sets to the US company. Each dining table set should include one square type foldable table and 6 foldable chairs. This is new territory for DD as the company has not exported its furniture so far. At the same time, DD would be under intense pressure as there are several furniture exporters in the Vietnamese market. This export order to the US company will provide significant financial support to DD during this pandemic time. Since Vietnam experienced a social distancing condition for a long time in 2021, DD could not achieve the expected sales volumes from the domestic market. However, with this export order, DD will be able to achieve considerable sales revenue. The DD company has sufficient inventory and the capacity to easily accommodate this order within the given timeline.

Until the pandemic hit Vietnam, DD Company has done well financially. While growth in sales has never been a strong point, margins were generally adequate and sales levels were steady. The company has never employed any long-term debt. The firm had a line of credit from a local bank, which had always provided sufficient funds to cover short-term financial needs. DD presently owed about VND 50 million on the credit line. DD has maintained an excellent relationship with the bank since the beginning.

Furniture Market in Vietnam

Exporting furniture is one of the main revenue-generating export industries in Vietnam. Therefore, the competition in the furniture industry in Vietnam is fierce. There are a few large dominant players in this market with a high concentration of market share. The Vietnam home furniture market manufactures kitchen furniture, living room furniture, bedroom furniture, and dining room furniture. It manufactures furniture for both indoor and outdoor purposes. Under the current free trade agreements of CPTPP (The Comprehensive and Progressive Agreement for Trans-Pacific Partnership) and EVFTA (European UnionVietnam Free Trade Agreement) the Vietnam government has signed with other countries; the local furniture manufacturers are gaining more accessibility and opportunities to cater to global markets such as Europe and US. In a recent newspaper article, Mai (2021) stated that the revenue from the wooden and forestry exports rose sharply by 43% in 2021. Despite the sector's outstanding performance to date, experts are concerned that the worldwide Covid-19 issue could harm export prospects to important markets such as the United States, the European Union, Japan, and South Korea.

New Export Order from the US

The purchasing manager of the US company has met the CEO of DD in virtual meetings to negotiate the pricing, terms, and conditions of this continued business agreement. The proposed new order is for 100 wooden garden dining sets each including one square-type foldable table and 6 foldable chairs. As per the export agreement, this order should be delivered to the US by the beginning of April 2022. The US company has agreed to share the shipping costs equally with DD. Therefore, DD company should only pay 50% of the shipping costs.

The US company has requested 30 days credit period to make the payment upon receipt of the furniture at the shipping facility. The CEO of DD has a concern about reliability as this is the first time they are doing business with this US company. The CEO of the DD believes that the payment for the new order will be received somewhere around 30 April 2022 assuming the order will be agreed upon immediately. The DD will receive the export revenue in USD. Exhibit 1 summarizes the price calculation for this order. The exchange rate is VND 22748/ USD as of 21 October 2021.

Exhibit 1

Decorative Designs - Price calculation per dining set (figures in USD)

Labor	45
Materials	195
Manufacturing overhead	30
Administrative overhead	30
Total costs	300
Profit margin (15%)	45
Cost-plus profit margin in dollars	345

Note:

Overhead was applied based on labor hours.

The raw materials expense was based on the original cost (book value) of the materials.

DD anticipated a 3-month manufacturing cycle once all the raw materials are in place. The production factory of DD company is in Ho Chi Minh City, and they buy a majority of their materials from the suppliers at Binh Dinh Province and it takes approximately 4-5 weeks to secure the required raw materials for the production. However, the DD has a sufficient inventory of materials to start the production immediately upon the receipt of the order, while arranging the purchase of the remaining materials required for the order.

Exchange Rate Risk

The CEO of DD Company has also gathered additional information on exchange-rate markets before meeting the financial consultant. He has downloaded the monthly USD to VND exchange rate from the Yahoo Finance website for the period from 01/01/2017 to 01/09/2021. The CEO is also looking for some information on estimated inflation rates and exchange rates for the year 2022. Exhibit 2 summarises the additional information the CEO has collected up to now. The CEO of DD also has discussed his concerns about the exchange rate fluctuations with the bank. The bank has explained to him the possibility of entering into a forward contract to mitigate the risk from this export order. The bank offers the DD Company the following forward agreement: a 6-month forward contract at the below-mentioned bid-ask rates for USD.

Exhibit 2

Additional Information

Exchange Rates for the USD as of 21/10/2021 (USD/VND)
Bid Rate on USD	22,750
Ask Rate on USD	23,789
Data source: State Bank of Vietnam
Standard Deviation of Monthly Exchange-Rate Changes
January 2017 September 2021	1.23%
First 9 months in 2021	0.28%
Data source: Yahoo Finance
Forward Rate Quotes for 6 Months Forward Contracts from the Bank
Bid Rate on USD	22,850.44
Ask Rate on USD	22,874.13
Inflation Rates
Vietnam Average CPI Inflation in 9 months of 2021	1.82%
United States Average CPI Inflation over last 12 months until September 2021	5.4%

Data source: General Statistics Office, Vietnam and US Department of Labour

1. A) Do some research and find the required data and forecast the Purchasing Power Parity (PPP) based exchange rate for 2022. (You need to explain your assumptions, data, mention the sources of data used and explain why you forecast the inflation rates to be at that level). B) Assuming the PPP exchange rate calculated in part A holds in the future, calculate the expected future cash flow from this new export order if DD will remain unhedged in the exchange rate risk. (6 Marks)

2. Should DD accept this new export order or not? Explain at least 2 reasons. If recommendation is to accept, which option would you recommend for DD to mitigate the exchange rate risk? Hedging with a forward contract or unhedged position? Justify your decision. (4 Marks)