Question: find the NPV, fill the rest of the table base on the provided case study.

I attached 2 excel tables wich some numbers calculated and need the other number to find out base on the tables provided in the case study

1989 Valuting financing Sunsidies 1981 401 5.57 72($) 29.8 Franch Bid (Year) principal and after Tax intrest (FF) Exchang Rate Principale and after Tax Intrest ($) NPV @ 20% ($) 1982 351 5.65635728 1983 1984 301 251 5.74405344 5.83310925 1985 201 5.923545774 1986 1987 151 101 6.015384427 6.10864695 1988 51 6.2033554 3 0 6.299532232 5 US 3 1982 1985 Japaness BID (year) principal and after Tax intrest (Y) Exchang Rate Principale and after Tax Intrest ($) NPV @ 20%($) Valuting financing Sunsidies 1981 16.354 227.15 72 24.8 14,719 216.9762 1983 1984 13,084 11,449 207.258053197.975172 9,814 189.1080621 1986 1987 8,179 6,544 180.6381011 172.547501 1988 4,909 164.81927 1989 1990 1991 3,274 1,6391 157.4371808 150.385727 143.650101 3 exbit 7 we can estimate the cost of If we don't exchange each of them and we Dicount them and just exchange @227.15 for yen 5.57 for franc net present value which we get we converted to dollar at 5.57 rate and what ever we get in japaness rate to dollar ar French Franc Discount Rate -21.9% Yen Dicount Rtae 14.6% 01 in 1.015504 0.955211 (1.179/1.161) (1.109/1.161) 7 3 Spot Exchange Rates FF/$ Y/$ 5.57 227.15 2 3 4 French Franc Discount Rate Yen Discount rate 21.9%% 14.60% French Franc Discount Rate Yen Discount rate 21.9%% 14.60% 1981 1982 1983 1984 1985 1986 1987 1988 1989 Depreaciation Tax Sheild gain/Loss french shipyard loan principale, ampotarzation, orginal loan basis ($) 9.00 9.00 9.00 9.00 9.00 9.00 9.00 9.00 9.00 Expected principal repaymnet ($) 8.80 8.70 8.60 0.20 0.10 0.30 0.15 0.40 0.20 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 FX gain Tax on gain NPV @ 20% S1 Japaness Shipyard Loan principale, ampotarzation, orginal loan basis ($) Expected principal repaymnet ($) FX Loss Tax shhield on Loss NPV @ 20% 7.2 7.2 7.2 7.2 7.2 7.2 7.2 7.2 7.2 7.2 7.5 Japaness Total Cost Of Hedging Forward Contract 1 year 2 year 5 year Total Money Market Hedging 1 year 2 year 5 year Total from table 2 FF -6.80% -4.00% 0% -10.80% FF 1.78 JPY 6.50% 6.80% 4.10% Y 8.2 ((1.2/1.109)-1)*100) 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 FF535 FF401 FF201 26 FF101 16 FF51 11 FF351 42 50 21 FF301 37 50 19 FF251 32 50 16 FF151 21 50 11 FFO 5 51 3 50 50 13 FF134 FF61 FF58 FF56 FF54 FF71 $15 7 FF69 $21 11 FF66 $20 10 FF63 $20 10 $20 10 FRENCH BID Loan Principal Interest @ 10.5% Prin. Repayment After-tax Interest Equity Outlay Prin..A.T.Int. Depreciation Depr. Tax Shield JAPANESE BID Loan Principal Interest @ 8.75% Prin. Repayment After-tax Interest Equity Outlay Prin.-A. Tint Depreciation Depr. Tax Shield 120,444 *16,354 $11,449 18,544 716 *14,719 1,431 1,635 715 $13,084 1.288 X1,635 644 19,814 1,002 $1,635 501 8,179 859 *1,635 430 14,909 573 1,635 287 13,274 430 *1,635 215 *1,639 286 1,635 143 NO 143 *1,635 72 $1,635 358 14,090 82,350 2.279 12,136 12,065 *1,993 1,922 1,850 *1,778 X1,711 $13 7 $20 10 12,207 $19 9 $19 9 $19 9 - 1981 8 199 1 7% ov. 1991 21-2 1 4 1974 2 B 286 3 12 2KW 11 um EN Source: International Financial Statistics, November 1981; International Monetary Fund "Seasonally adjusted Ocean Drilling, Inc. 282-050 -6- Exhibit 4 France: Balance of Payments ($ in billions) 1980 Trade balance fob Merchandise: exports fob Merchandise: imports fob Net other goods, services, and income Private unrequited transfers Official unrequited transfers Net capital flows other than reserves Net errors and omissions Counterpart items Other Total change reserves -12.0 107.5 -119.5 8.3 -2.5 -1.7 8.1 5.7 5.0 0.5 11.4 Volume of exports Volume of imports Unit value of exports Unit value of imports 139 152 153 163 Exhibit 5 Japan: Balance of Payments ($ in billions) CROVEOMA Posts 1977 1978 1979 1980 Trade balance fob Merchandise: exports fob Merchandise: imports fob Net other goods, services, and income Private unrequited transfers Official unrequited transfers Net capital flows other than reserves Net errors and omissions Counterpart items Total change in reserves 17.20 79.2 -62.0 -5.85 -.07 -33 -5.07 .67 .13 6.68 25.30 95.3 -70.0 -7.04 -26 -41 -7.77 .15 20 10.17 1.70 101.1 -99.4 -9.39 -.25 -.85 NO 2.10 126.7 -124.6 -11.3 - 25 -1.26 18.85 -6.77 -3.12 2.38 26 -12.87 .09 5.11 Volume of exports Volume of imports Unit value of exports Unit value of imports 133 111 98 100 134 119 92 82 133 132 102 107 155 124 114 150 This document is authorized for educator review use only by HAROON UR RASHID KHAN, King Abdulaziz University until Apr 2021. Copying or posting is an infringement of copyright. Permissions@hep.harvard.edu or 617.783.7860 Ocean Drilling, Inc. On November 16, 1981, the Board of Directors of Ocean Drilling, Inc., was confronted with a choice between bids by two foreign shipyards on two semisubmersible drilling rigs. The company had planned to purchase the rigs from a U.S. shipyard with financing facilitated by the Maritime administration's loan guarantee program. To its dismay, President Reagan's determination to cut government programs resulted in a sharp reduction of the Maritime administration's loan guarantee activities. With $2.7 billion of requests for loan guarantees and only $900 million to allocate for fiscal- year 1982, the agency seemed likely to scuttle ali drilling loan bids and to concentrate on encouraging ship construction Management was forced to choose between two alternative bids: one by a Japanese shipyard for $90 million; a second by a French shipyard for $96 million. Both proposals involved possible exchange risks associated with changes in the value of these currencies. This risk was an important consideration since 75% to 80% of the cost of the rigs would be financed in the country and therefore the currencywhere the shipyard was located. The members of the Board acknowledged that they were not experts in the foreign exchange market. Indeed, they wondered if such a person existed. Responsibility was assigned to Geoffrey Moore, the assistant treasurer, to analyze in detail the foreign exchange risks involved in the Japanese and French proposals. A summary description of the two proposals is contained in Exhibit 1. The Offshore Drilling Industry The offshore drilling industry had experienced rapid growth since 1973, fueled by the fifteenfold increase in oil prices (see Table 1). Revenues rose 25% annually as more expensive rigs were added to the fleet, and daily rates were increased. By 1981, every available mobile rig in the world was under contract, often for as long as two years, at daily rates that had doubled in less than three years to $75,000 a day for the large semisubmersibles. Table 1 Growth of Offshore Drilling Industry, 1970-1980 1970 1980 $ 194 471 8,041 Number of rigs Revenues per day $1,560,000 $15,000,000 Revenues per rig per day 31,847 Ocean Drilling's management was intent on establishing itself among the leaders in the industry. Capital outlays were scheduled at more than $250 million per year through 1985 substantial undertaking for a company with an estimated net worth at year-end 1981 of only $194 million, a bond rating of BB, and erratic earnings. Exhibit 2 summarizes Ocean Drilling's past financial performance The financial community was not comfortable with the aggressive spending plans. Its concern was reflected in the 20% yield on Ocean Drilling's most recent public debt offering. Some industry observers feared that a glut might develop when the 200 rigs on order worldwide came on- stream. Rumor had it that one of the industry leaders was holding back on fleet expansion, expecting to pick up rigs from other operators at fire-sale prices. Ocean Drilling's management was confident, however, that any downturn would be brief. The president commented: Right now it is hard to say if the industry is overbuilding because the real impact of thirty-dollar oil is not fully understood. Using historical experience to build future scenarios may not be a valid approach anymore. People cite the so-called cycle theory which says the industry will move into an overbuilt situation every five to six years. However, in the last seven years the price of oil has increased almost fifteenfold. The rig population during this time increased twofold. There is obviously room for a lot of expansion and we plan to capitalize fully on the opportunity. The large spending program would be financed by a combination of sharply higher earnings and continued heavy use of debt Shipyard financing at rates of 9% to 10% (versus the 20% yield on the company's most recent public debt issue) would keep total interest expense in line with earnings. (See Exhibit 3 for projected income statements and capitalizations.) Forecasting Exchange Rates The magnitude of the proposed shipyard financings required careful analysis of possible changes in exchange rates. Mr. Moore asked his assistants to compile economic data for Japan, France, and the United States. (See Exhibits 4-7.) He also reviewed information culled from recent reports on each country, as summarized in Exhibit 8. Hedging Policies Mr. Moore was considering two methods to protect Ocean Drilling against the risks involved in borrowing in a foreign currency. One possibility was to sell U.S. dollars for French francs or Japanese yen in the forward market. Moore thought that it would be very difficult to buy a single forward contract to cover the life of the loan from either shipyard. Nervousness over Mitterrand's 2 ocument is authorized for educator review use only by HAROON UR RASHID KHAN, King Abdulaziz University until Apr 2021. Copying or posting is an infringement of cop Ocean Drilling, Inc. 282-050 socialist policies made it unlikely that a contract beyond two years could be found at a reasonable price. In contrast, it would be possible to negotiate a five-year forward contract in yen. Market Rates, November 16, 1981 Exchange Rates Spot 6 Month 12 Month 2 Year 5 Year FF/$ 5.570-5.580 5.6775(-4.0) 5.7800(-3.8) 8.0300(-4.0) not available 227.15-227.30 219.95(+6.3) 212.40(+8.5) 197.25(+0.8) 184. 15(+4.1%) 5 Year 13.44% 17.50 13.75% 18.00 19.00 8.25 7.62 7.55 Interbank Deposit Rates 6 Month 12 Month Eurodollars 15.50% Euro French france Euroyen "The figures in parentheses are the annual percentage change and are based on the bid rate. The other possibility was to borrow in the United States at 20%, convert the proceeds into French francs or Japanese yen, and invest them in France or Japan at the prevailing rates. While this seemed fairly straightforward in dealing with the risks, it was also expensive. Moore suspected that management would be unwilling to invest in anything other than a Japanese or French government security. A borrowing/investing hedge would involve a substantial spread due to the difference in credit worthiness. In view of the disadvantages of each of the hedging alternatives, Moore wondered if the best move was to leave the exchange risk uncovered. 282-050 Ocean Drilling, Inc. Exhibit 1 Summary of Shipyard Proposals French Shipyard Total bid price of rige FF535 million Exchange rate on November 18 5.570 (FF/8) U.S. dollar bid equivalent $96 million Amount of shipyard financing 75% Currency Frano Maturity 8 years Payment schedule equal annual payments Interest rate 10 % Required downpayment by Ocean Drilling $24 million Japanese Shipyard 20,444 million 227.15 (4/5) $90 million 80% Yen 10 years equal annual payments 8/% $18 million 1978 1979 1980 $122 $136 $173 32 -3 21 11 10 59 17 42 18 4 sam 1999 $15 $ 33 37999303 Exhibit 2 Summary of Financial Performance ($ in millions) 1974 1975 1976 1977 Total revenues $ 47 $ 81 $ 86 $ 99 Earnings before interest and taxes 13 11 15 10 Interest 4 11 Profit before taxes 10 7 6 (1) Taxes 4 0 Net income $ 5 Cash flow from $ 13 $ 14 $ 16 $ 11 operations Capital expenditures $ 28 $ 23 $ 28 $ 32 Times interest earned 4.3 2.8 1.7 .9 Return on average 13% 10% 9% def. equity Per share: Earning $ .37 $.32 $ .31 ($.00) Dividends .03 .03 0 Book value 33.10 $3.39 $3.66 $3.80 Market-high 3 1/4 3 7/8 3 1/2 3 -low 1 7/8 2 1 578 112 $36 $ 58 $ 19 $ 41 1.9 10% $ 71 2.3 21% $ 156 3.5 32% 03 $.36 0 $3.96 4 1/8 1 3/4 $.92 0 $4.88 9 1/4 2 7/8 $2.02 0 $7.80 43 10 Ocean Drilling, Inc. 282-050 15 -5 Exhibit 2 (Continued) Balance Sheet at December 31, 1980 ($ in millions) Assets Liabilities and Equity Cash Accounts payable $ 13 Accounts receivable 32 Accrued liabilities Inventories 10 Accrued taxes Prepaid expenses Current portion long-term debt Total 55 Total 44 Construction funde in esorow 17 Deferred income taxes 8 Gross plant and equipment 386 Other long-term liabilities 6 (-) Accumulated depreciation 87 Long-term senior debt 124 Net plant & equipment 299 Convertible subordinated debt 50 Shareholders' equity 139 Total Asseto $8711 Total $371 Note: Under the terms of a borrowing agreement, the current ratio must be at least equal to 1.2 and the ratio of senior debt to the sum of subordinated debt plus shareholders' equity may not exceed 1.25. Exhibit 3 Projections, 19811985 ($ in millions) 1981 1982 1983 1984 1985 $561 Revenues Earnings before interest and taxes Interest Profit before tax Tax Net income Earninge per share Number of shares Long-term debt Convertible subordinated debt Shareholders' equity Total C $262 117 30 87 22 $ 65 $3.65 $407 180 43 137 82 105 $5.90 220 60 160 48 $ 112 $6.29 -17.8 million $440 50 411 $901 $888 330 80 250 90 $ 160 $8.99 $1,309 500 100 400 172 3228 $12.81 $240 50 1194 $484 $364 50 299 $713 $640 50 571 $1,261 $840 50 799 $1,689 Ocean Drilling, Inc. 282-050 Exhibit 8 Excerpts from Various Reports Ost France President Francois Mitterrand is moving faster than his critics had feared in imposing far- reaching controls on France's economy. In doing so, his Socialist government may be headed for serious troubles starting in 1983, following a spurt of inflationary growth that is expected in the year ahead as a result of the government's expansionary spending and job-creating policies. In an attempt to roll inflation back to 10% from its current annual rate of 14% and halt the erosion of the French franc, Finance Minister Jacques Delors on October 5, clamped a price freeze on basic products. He also took a long step toward imposing an "incomes policy" by announcing that he would confer with labor unions on moderating pay demands. Withdrawal from the EMS? The moves are seen as part of a growing "radicalization" of the French economy by the government of Mitterrand, which is putting its main emphasis on creating jobs through growth rather than fighting inflation at a time when most other industrial countries are reining in their economies in order to curb spiraling prices. The resulting weakness of the franc, which fell from twenty-two cents at the beginning of the year to eighteen cents on October 2, forced Mitterrand to devalue the franc within the European Monetary System. Initially, the franc strengthened again, but German bankers predict that further devaluations, possibly culminating in French withdrawal from the EMS, will be an almost inevitable consequence of Mitterrand's "dash for growth." The centerpiece of Mitterrand's strategy is his first budget, unveiled on September 30, which envisages a $17 billion deficit for 1982, at least 50% higher than the 1981 deficit. Delors now says he will try to trim some outlays, but the Keynesian budget is complemented by measures last summer to give consumer spending a quick boost with a 10% increase in the minimum wage and big increases in social welfare. The result next year, most forecasters agree, will be a spurt of real growth that should come close to the government's target of 3.3% after near-zero growth in 1981. For the sluggish economies of France's European trading partners, Mitterrand's pump-priming may provide a welcome stimulus. But for France itself, economist Ulrich Schroder of Germany's Westdeutsche Landesbank warns, the program is "Socialist short-term policy designed to achieve quick, visible results" without considering the adverse consequences two or three years down the road. Adds Philippe Scheuer, economist for Data Resources International in Brussels: "The favorable effects of the [French government's] policy will be felt in 1982, and it is only after that they face problems. 1983 is the dangerous year..." Numerous obstacles. Not all Europeans are so pessimistic. "I firmly believe the only way to encourage new investment is through growth, not restraint," says Ken E. Mathysen-Gerst, president of Geneva-based Capital International. "Inflation is a consequence, but it can be managed." Nevertheless, he warns, "the French transition is going to be Europe's most difficult question of the next two years." Numerous obstacles may derail Mitterrand's strategy. One is the disparity between Mitterrand's expansionary internal policy and the sluggishness of the world economy. The risk is that imports will flood into France while exports languish, thus worsening a balance-of-payments deficit on current account that is running at a $7.9 billion annual rate. French attempts to slow the fall of the franc by strict exchange controls and a two-tier structure of interest rates are creating problems for 282-050 Ocean Drilling, Inc. the rest of Europe. There is also a basic contradiction between Mitterrand's vow to "reconquer the internal market" for French industriesa policy dubbed by Italian newspapers as "pink protectionism"and the need to support open international markets for high-technology industries into which the government plans to pour resources. Equally contradictory are the goals of promoting an innovative and dynamic small and medium-sized business sector while levying higher taxes on both income and capital. The umbrella over such goals is a two-stage Socialist strategy for growth, starting with a two- year push to create jobs and expand consumption. The second stage, following the extensive nationalizations, is a French version of supply-side economics that starts from very different premises than those of its U.S. counterpart. It is based on the judgment that the private sector has failed because, as stated in the preamble to the nationalization bill, "from 1974 through 1980, investment by public sector enterprises rose 91% in volume, while private investment fell 5%." In this situation, says a top French official, government-controlled enterprises must "run against the tide" and develop long-term strategies that will produce spinoff benefits for private business. Japan2 Early in 1981 the year continued to benefit in the exchanges from rapid adjustment of Japan's economy to the second oil shock. Restrictive monetary and fiscal policies had successfully curtailed domestic demand, limited the buildup of inflationary expectations, and together with moderate wage settlements, contained the impact of oil price increases on domestic costs. At the same time, changes in production processes under way since the mid-1970s had made industry less dependent on imported raw materials, particularly oil. These developments, together with the impact of the 1979 80 depreciation of the yen, led to a marked improvement in the current account, which swung from deep deficit to virtual balance. They also impressed international investors sufficiently to attract massive inflows of funds, particularly from OPEC investors eager to increase the share of yen- denominated assets in their portfolios. Meanwhile, domestic demand had stalled, and with the improvement in Japan's external position, the authorities had begun to relax the tight stance of policy after mid-1980. Yet, by early 1981, consumption and residential construction continued to falter, and business fixed investment, previously the only domestic source of strength, was also decelerating rapidly. The growth of the monetary aggregates had slowed, and yen money market rates softened. Inflationary pressures had eased, partly reflecting the dampening impact on import prices of the yen's appreciation, so that wholesale price inflation had dropped from a year-on-year rate of 24% in the spring of 1980 to about 5% in early 1981. A major factor was the moderate 7% wage increases agreed by the unions in 1980. On March 17, the government introduced a fiscal package which accelerated budgeted public-works expenditures and provided low-cost financing to promote housing construction, to aid small companies, and to boost exports of industrial plants. But the authorities were also concerned that the large interest differentials adverse to the yen might trigger volatile capital outflows. Pressures against the yen intensified considerably during July as the long-awaited decline in U.S. interest rates failed to materialize. With little prospect that large interest differentials adverse to the yen would narrow and that the currency would soon rebound against the dollar, a broad range of participants accelerated their sales of yen in an effort to limit losses. At the same time, foreign corporations stepped up short-term yen borrowings to meet financing needs in other currencies, while commercial leads and lags also shifted against the yen. As the flow of funds gathered force, the 2 Based on "Treasury and Federal Reserve Foreign Exchange Operations," Federal Reserve Bank of New York, decline of the yen began to outpace the fall of the European currencies against the rapidly strengthening dollar. On July 31, the yen closed at 240, down 17% against the dollar since January. United States The economy is entering a critical test period. After six months of essentially lateral movement, the big question now is whether cumulative deterioration will set in, tipping the nation into a new recession. Crucial, too, at this juncture is the direction that monetary and budget policies will take in a settling of nervous and unsettled financial markets. Increased speculation that the economy is in a slump may be premature. There is no certainty that the small slippage in GNP will continue in light of the lift that will be provided by the tax cuts and the growth in defense spending. The cause of the current softness is essentially Federal Reserve restraint. With that restraint now lessening, there is a good prospect that recessionary tendencies will not cumulate. Fiscal policy, meanwhile, faces its own critical test. Scarcely two months after historic victories in cutting the budget, President Reagan came back with a second slice. The ultimate response in Congress seems unclear. Since mid-July the demand for credit in the United States has been stubbornly strong in the face of high interest rates. The market seems impressed by Chairman Volcker's reaffirmation of the Federal Reserve's commitment to restrain monetary expansion. In addition, the market is increasingly concerned about the impact of the U.S. government's budget deficits and near-term financing requirements on U.S.financial markets. In this environment, interest rates remain high, and the dollar remained strong. Inflation continues at a 10% annual rate. 1989 Valuting financing Sunsidies 1981 401 5.57 72($) 29.8 Franch Bid (Year) principal and after Tax intrest (FF) Exchang Rate Principale and after Tax Intrest ($) NPV @ 20% ($) 1982 351 5.65635728 1983 1984 301 251 5.74405344 5.83310925 1985 201 5.923545774 1986 1987 151 101 6.015384427 6.10864695 1988 51 6.2033554 3 0 6.299532232 5 US 3 1982 1985 Japaness BID (year) principal and after Tax intrest (Y) Exchang Rate Principale and after Tax Intrest ($) NPV @ 20%($) Valuting financing Sunsidies 1981 16.354 227.15 72 24.8 14,719 216.9762 1983 1984 13,084 11,449 207.258053197.975172 9,814 189.1080621 1986 1987 8,179 6,544 180.6381011 172.547501 1988 4,909 164.81927 1989 1990 1991 3,274 1,6391 157.4371808 150.385727 143.650101 3 exbit 7 we can estimate the cost of If we don't exchange each of them and we Dicount them and just exchange @227.15 for yen 5.57 for franc net present value which we get we converted to dollar at 5.57 rate and what ever we get in japaness rate to dollar ar French Franc Discount Rate -21.9% Yen Dicount Rtae 14.6% 01 in 1.015504 0.955211 (1.179/1.161) (1.109/1.161) 7 3 Spot Exchange Rates FF/$ Y/$ 5.57 227.15 2 3 4 French Franc Discount Rate Yen Discount rate 21.9%% 14.60% French Franc Discount Rate Yen Discount rate 21.9%% 14.60% 1981 1982 1983 1984 1985 1986 1987 1988 1989 Depreaciation Tax Sheild gain/Loss french shipyard loan principale, ampotarzation, orginal loan basis ($) 9.00 9.00 9.00 9.00 9.00 9.00 9.00 9.00 9.00 Expected principal repaymnet ($) 8.80 8.70 8.60 0.20 0.10 0.30 0.15 0.40 0.20 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 FX gain Tax on gain NPV @ 20% S1 Japaness Shipyard Loan principale, ampotarzation, orginal loan basis ($) Expected principal repaymnet ($) FX Loss Tax shhield on Loss NPV @ 20% 7.2 7.2 7.2 7.2 7.2 7.2 7.2 7.2 7.2 7.2 7.5 Japaness Total Cost Of Hedging Forward Contract 1 year 2 year 5 year Total Money Market Hedging 1 year 2 year 5 year Total from table 2 FF -6.80% -4.00% 0% -10.80% FF 1.78 JPY 6.50% 6.80% 4.10% Y 8.2 ((1.2/1.109)-1)*100) 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 FF535 FF401 FF201 26 FF101 16 FF51 11 FF351 42 50 21 FF301 37 50 19 FF251 32 50 16 FF151 21 50 11 FFO 5 51 3 50 50 13 FF134 FF61 FF58 FF56 FF54 FF71 $15 7 FF69 $21 11 FF66 $20 10 FF63 $20 10 $20 10 FRENCH BID Loan Principal Interest @ 10.5% Prin. Repayment After-tax Interest Equity Outlay Prin..A.T.Int. Depreciation Depr. Tax Shield JAPANESE BID Loan Principal Interest @ 8.75% Prin. Repayment After-tax Interest Equity Outlay Prin.-A. Tint Depreciation Depr. Tax Shield 120,444 *16,354 $11,449 18,544 716 *14,719 1,431 1,635 715 $13,084 1.288 X1,635 644 19,814 1,002 $1,635 501 8,179 859 *1,635 430 14,909 573 1,635 287 13,274 430 *1,635 215 *1,639 286 1,635 143 NO 143 *1,635 72 $1,635 358 14,090 82,350 2.279 12,136 12,065 *1,993 1,922 1,850 *1,778 X1,711 $13 7 $20 10 12,207 $19 9 $19 9 $19 9 - 1981 8 199 1 7% ov. 1991 21-2 1 4 1974 2 B 286 3 12 2KW 11 um EN Source: International Financial Statistics, November 1981; International Monetary Fund "Seasonally adjusted Ocean Drilling, Inc. 282-050 -6- Exhibit 4 France: Balance of Payments ($ in billions) 1980 Trade balance fob Merchandise: exports fob Merchandise: imports fob Net other goods, services, and income Private unrequited transfers Official unrequited transfers Net capital flows other than reserves Net errors and omissions Counterpart items Other Total change reserves -12.0 107.5 -119.5 8.3 -2.5 -1.7 8.1 5.7 5.0 0.5 11.4 Volume of exports Volume of imports Unit value of exports Unit value of imports 139 152 153 163 Exhibit 5 Japan: Balance of Payments ($ in billions) CROVEOMA Posts 1977 1978 1979 1980 Trade balance fob Merchandise: exports fob Merchandise: imports fob Net other goods, services, and income Private unrequited transfers Official unrequited transfers Net capital flows other than reserves Net errors and omissions Counterpart items Total change in reserves 17.20 79.2 -62.0 -5.85 -.07 -33 -5.07 .67 .13 6.68 25.30 95.3 -70.0 -7.04 -26 -41 -7.77 .15 20 10.17 1.70 101.1 -99.4 -9.39 -.25 -.85 NO 2.10 126.7 -124.6 -11.3 - 25 -1.26 18.85 -6.77 -3.12 2.38 26 -12.87 .09 5.11 Volume of exports Volume of imports Unit value of exports Unit value of imports 133 111 98 100 134 119 92 82 133 132 102 107 155 124 114 150 This document is authorized for educator review use only by HAROON UR RASHID KHAN, King Abdulaziz University until Apr 2021. Copying or posting is an infringement of copyright. Permissions@hep.harvard.edu or 617.783.7860 Ocean Drilling, Inc. On November 16, 1981, the Board of Directors of Ocean Drilling, Inc., was confronted with a choice between bids by two foreign shipyards on two semisubmersible drilling rigs. The company had planned to purchase the rigs from a U.S. shipyard with financing facilitated by the Maritime administration's loan guarantee program. To its dismay, President Reagan's determination to cut government programs resulted in a sharp reduction of the Maritime administration's loan guarantee activities. With $2.7 billion of requests for loan guarantees and only $900 million to allocate for fiscal- year 1982, the agency seemed likely to scuttle ali drilling loan bids and to concentrate on encouraging ship construction Management was forced to choose between two alternative bids: one by a Japanese shipyard for $90 million; a second by a French shipyard for $96 million. Both proposals involved possible exchange risks associated with changes in the value of these currencies. This risk was an important consideration since 75% to 80% of the cost of the rigs would be financed in the country and therefore the currencywhere the shipyard was located. The members of the Board acknowledged that they were not experts in the foreign exchange market. Indeed, they wondered if such a person existed. Responsibility was assigned to Geoffrey Moore, the assistant treasurer, to analyze in detail the foreign exchange risks involved in the Japanese and French proposals. A summary description of the two proposals is contained in Exhibit 1. The Offshore Drilling Industry The offshore drilling industry had experienced rapid growth since 1973, fueled by the fifteenfold increase in oil prices (see Table 1). Revenues rose 25% annually as more expensive rigs were added to the fleet, and daily rates were increased. By 1981, every available mobile rig in the world was under contract, often for as long as two years, at daily rates that had doubled in less than three years to $75,000 a day for the large semisubmersibles. Table 1 Growth of Offshore Drilling Industry, 1970-1980 1970 1980 $ 194 471 8,041 Number of rigs Revenues per day $1,560,000 $15,000,000 Revenues per rig per day 31,847 Ocean Drilling's management was intent on establishing itself among the leaders in the industry. Capital outlays were scheduled at more than $250 million per year through 1985 substantial undertaking for a company with an estimated net worth at year-end 1981 of only $194 million, a bond rating of BB, and erratic earnings. Exhibit 2 summarizes Ocean Drilling's past financial performance The financial community was not comfortable with the aggressive spending plans. Its concern was reflected in the 20% yield on Ocean Drilling's most recent public debt offering. Some industry observers feared that a glut might develop when the 200 rigs on order worldwide came on- stream. Rumor had it that one of the industry leaders was holding back on fleet expansion, expecting to pick up rigs from other operators at fire-sale prices. Ocean Drilling's management was confident, however, that any downturn would be brief. The president commented: Right now it is hard to say if the industry is overbuilding because the real impact of thirty-dollar oil is not fully understood. Using historical experience to build future scenarios may not be a valid approach anymore. People cite the so-called cycle theory which says the industry will move into an overbuilt situation every five to six years. However, in the last seven years the price of oil has increased almost fifteenfold. The rig population during this time increased twofold. There is obviously room for a lot of expansion and we plan to capitalize fully on the opportunity. The large spending program would be financed by a combination of sharply higher earnings and continued heavy use of debt Shipyard financing at rates of 9% to 10% (versus the 20% yield on the company's most recent public debt issue) would keep total interest expense in line with earnings. (See Exhibit 3 for projected income statements and capitalizations.) Forecasting Exchange Rates The magnitude of the proposed shipyard financings required careful analysis of possible changes in exchange rates. Mr. Moore asked his assistants to compile economic data for Japan, France, and the United States. (See Exhibits 4-7.) He also reviewed information culled from recent reports on each country, as summarized in Exhibit 8. Hedging Policies Mr. Moore was considering two methods to protect Ocean Drilling against the risks involved in borrowing in a foreign currency. One possibility was to sell U.S. dollars for French francs or Japanese yen in the forward market. Moore thought that it would be very difficult to buy a single forward contract to cover the life of the loan from either shipyard. Nervousness over Mitterrand's 2 ocument is authorized for educator review use only by HAROON UR RASHID KHAN, King Abdulaziz University until Apr 2021. Copying or posting is an infringement of cop Ocean Drilling, Inc. 282-050 socialist policies made it unlikely that a contract beyond two years could be found at a reasonable price. In contrast, it would be possible to negotiate a five-year forward contract in yen. Market Rates, November 16, 1981 Exchange Rates Spot 6 Month 12 Month 2 Year 5 Year FF/$ 5.570-5.580 5.6775(-4.0) 5.7800(-3.8) 8.0300(-4.0) not available 227.15-227.30 219.95(+6.3) 212.40(+8.5) 197.25(+0.8) 184. 15(+4.1%) 5 Year 13.44% 17.50 13.75% 18.00 19.00 8.25 7.62 7.55 Interbank Deposit Rates 6 Month 12 Month Eurodollars 15.50% Euro French france Euroyen "The figures in parentheses are the annual percentage change and are based on the bid rate. The other possibility was to borrow in the United States at 20%, convert the proceeds into French francs or Japanese yen, and invest them in France or Japan at the prevailing rates. While this seemed fairly straightforward in dealing with the risks, it was also expensive. Moore suspected that management would be unwilling to invest in anything other than a Japanese or French government security. A borrowing/investing hedge would involve a substantial spread due to the difference in credit worthiness. In view of the disadvantages of each of the hedging alternatives, Moore wondered if the best move was to leave the exchange risk uncovered. 282-050 Ocean Drilling, Inc. Exhibit 1 Summary of Shipyard Proposals French Shipyard Total bid price of rige FF535 million Exchange rate on November 18 5.570 (FF/8) U.S. dollar bid equivalent $96 million Amount of shipyard financing 75% Currency Frano Maturity 8 years Payment schedule equal annual payments Interest rate 10 % Required downpayment by Ocean Drilling $24 million Japanese Shipyard 20,444 million 227.15 (4/5) $90 million 80% Yen 10 years equal annual payments 8/% $18 million 1978 1979 1980 $122 $136 $173 32 -3 21 11 10 59 17 42 18 4 sam 1999 $15 $ 33 37999303 Exhibit 2 Summary of Financial Performance ($ in millions) 1974 1975 1976 1977 Total revenues $ 47 $ 81 $ 86 $ 99 Earnings before interest and taxes 13 11 15 10 Interest 4 11 Profit before taxes 10 7 6 (1) Taxes 4 0 Net income $ 5 Cash flow from $ 13 $ 14 $ 16 $ 11 operations Capital expenditures $ 28 $ 23 $ 28 $ 32 Times interest earned 4.3 2.8 1.7 .9 Return on average 13% 10% 9% def. equity Per share: Earning $ .37 $.32 $ .31 ($.00) Dividends .03 .03 0 Book value 33.10 $3.39 $3.66 $3.80 Market-high 3 1/4 3 7/8 3 1/2 3 -low 1 7/8 2 1 578 112 $36 $ 58 $ 19 $ 41 1.9 10% $ 71 2.3 21% $ 156 3.5 32% 03 $.36 0 $3.96 4 1/8 1 3/4 $.92 0 $4.88 9 1/4 2 7/8 $2.02 0 $7.80 43 10 Ocean Drilling, Inc. 282-050 15 -5 Exhibit 2 (Continued) Balance Sheet at December 31, 1980 ($ in millions) Assets Liabilities and Equity Cash Accounts payable $ 13 Accounts receivable 32 Accrued liabilities Inventories 10 Accrued taxes Prepaid expenses Current portion long-term debt Total 55 Total 44 Construction funde in esorow 17 Deferred income taxes 8 Gross plant and equipment 386 Other long-term liabilities 6 (-) Accumulated depreciation 87 Long-term senior debt 124 Net plant & equipment 299 Convertible subordinated debt 50 Shareholders' equity 139 Total Asseto $8711 Total $371 Note: Under the terms of a borrowing agreement, the current ratio must be at least equal to 1.2 and the ratio of senior debt to the sum of subordinated debt plus shareholders' equity may not exceed 1.25. Exhibit 3 Projections, 19811985 ($ in millions) 1981 1982 1983 1984 1985 $561 Revenues Earnings before interest and taxes Interest Profit before tax Tax Net income Earninge per share Number of shares Long-term debt Convertible subordinated debt Shareholders' equity Total C $262 117 30 87 22 $ 65 $3.65 $407 180 43 137 82 105 $5.90 220 60 160 48 $ 112 $6.29 -17.8 million $440 50 411 $901 $888 330 80 250 90 $ 160 $8.99 $1,309 500 100 400 172 3228 $12.81 $240 50 1194 $484 $364 50 299 $713 $640 50 571 $1,261 $840 50 799 $1,689 Ocean Drilling, Inc. 282-050 Exhibit 8 Excerpts from Various Reports Ost France President Francois Mitterrand is moving faster than his critics had feared in imposing far- reaching controls on France's economy. In doing so, his Socialist government may be headed for serious troubles starting in 1983, following a spurt of inflationary growth that is expected in the year ahead as a result of the government's expansionary spending and job-creating policies. In an attempt to roll inflation back to 10% from its current annual rate of 14% and halt the erosion of the French franc, Finance Minister Jacques Delors on October 5, clamped a price freeze on basic products. He also took a long step toward imposing an "incomes policy" by announcing that he would confer with labor unions on moderating pay demands. Withdrawal from the EMS? The moves are seen as part of a growing "radicalization" of the French economy by the government of Mitterrand, which is putting its main emphasis on creating jobs through growth rather than fighting inflation at a time when most other industrial countries are reining in their economies in order to curb spiraling prices. The resulting weakness of the franc, which fell from twenty-two cents at the beginning of the year to eighteen cents on October 2, forced Mitterrand to devalue the franc within the European Monetary System. Initially, the franc strengthened again, but German bankers predict that further devaluations, possibly culminating in French withdrawal from the EMS, will be an almost inevitable consequence of Mitterrand's "dash for growth." The centerpiece of Mitterrand's strategy is his first budget, unveiled on September 30, which envisages a $17 billion deficit for 1982, at least 50% higher than the 1981 deficit. Delors now says he will try to trim some outlays, but the Keynesian budget is complemented by measures last summer to give consumer spending a quick boost with a 10% increase in the minimum wage and big increases in social welfare. The result next year, most forecasters agree, will be a spurt of real growth that should come close to the government's target of 3.3% after near-zero growth in 1981. For the sluggish economies of France's European trading partners, Mitterrand's pump-priming may provide a welcome stimulus. But for France itself, economist Ulrich Schroder of Germany's Westdeutsche Landesbank warns, the program is "Socialist short-term policy designed to achieve quick, visible results" without considering the adverse consequences two or three years down the road. Adds Philippe Scheuer, economist for Data Resources International in Brussels: "The favorable effects of the [French government's] policy will be felt in 1982, and it is only after that they face problems. 1983 is the dangerous year..." Numerous obstacles. Not all Europeans are so pessimistic. "I firmly believe the only way to encourage new investment is through growth, not restraint," says Ken E. Mathysen-Gerst, president of Geneva-based Capital International. "Inflation is a consequence, but it can be managed." Nevertheless, he warns, "the French transition is going to be Europe's most difficult question of the next two years." Numerous obstacles may derail Mitterrand's strategy. One is the disparity between Mitterrand's expansionary internal policy and the sluggishness of the world economy. The risk is that imports will flood into France while exports languish, thus worsening a balance-of-payments deficit on current account that is running at a $7.9 billion annual rate. French attempts to slow the fall of the franc by strict exchange controls and a two-tier structure of interest rates are creating problems for 282-050 Ocean Drilling, Inc. the rest of Europe. There is also a basic contradiction between Mitterrand's vow to "reconquer the internal market" for French industriesa policy dubbed by Italian newspapers as "pink protectionism"and the need to support open international markets for high-technology industries into which the government plans to pour resources. Equally contradictory are the goals of promoting an innovative and dynamic small and medium-sized business sector while levying higher taxes on both income and capital. The umbrella over such goals is a two-stage Socialist strategy for growth, starting with a two- year push to create jobs and expand consumption. The second stage, following the extensive nationalizations, is a French version of supply-side economics that starts from very different premises than those of its U.S. counterpart. It is based on the judgment that the private sector has failed because, as stated in the preamble to the nationalization bill, "from 1974 through 1980, investment by public sector enterprises rose 91% in volume, while private investment fell 5%." In this situation, says a top French official, government-controlled enterprises must "run against the tide" and develop long-term strategies that will produce spinoff benefits for private business. Japan2 Early in 1981 the year continued to benefit in the exchanges from rapid adjustment of Japan's economy to the second oil shock. Restrictive monetary and fiscal policies had successfully curtailed domestic demand, limited the buildup of inflationary expectations, and together with moderate wage settlements, contained the impact of oil price increases on domestic costs. At the same time, changes in production processes under way since the mid-1970s had made industry less dependent on imported raw materials, particularly oil. These developments, together with the impact of the 1979 80 depreciation of the yen, led to a marked improvement in the current account, which swung from deep deficit to virtual balance. They also impressed international investors sufficiently to attract massive inflows of funds, particularly from OPEC investors eager to increase the share of yen- denominated assets in their portfolios. Meanwhile, domestic demand had stalled, and with the improvement in Japan's external position, the authorities had begun to relax the tight stance of policy after mid-1980. Yet, by early 1981, consumption and residential construction continued to falter, and business fixed investment, previously the only domestic source of strength, was also decelerating rapidly. The growth of the monetary aggregates had slowed, and yen money market rates softened. Inflationary pressures had eased, partly reflecting the dampening impact on import prices of the yen's appreciation, so that wholesale price inflation had dropped from a year-on-year rate of 24% in the spring of 1980 to about 5% in early 1981. A major factor was the moderate 7% wage increases agreed by the unions in 1980. On March 17, the government introduced a fiscal package which accelerated budgeted public-works expenditures and provided low-cost financing to promote housing construction, to aid small companies, and to boost exports of industrial plants. But the authorities were also concerned that the large interest differentials adverse to the yen might trigger volatile capital outflows. Pressures against the yen intensified considerably during July as the long-awaited decline in U.S. interest rates failed to materialize. With little prospect that large interest differentials adverse to the yen would narrow and that the currency would soon rebound against the dollar, a broad range of participants accelerated their sales of yen in an effort to limit losses. At the same time, foreign corporations stepped up short-term yen borrowings to meet financing needs in other currencies, while commercial leads and lags also shifted against the yen. As the flow of funds gathered force, the 2 Based on "Treasury and Federal Reserve Foreign Exchange Operations," Federal Reserve Bank of New York, decline of the yen began to outpace the fall of the European currencies against the rapidly strengthening dollar. On July 31, the yen closed at 240, down 17% against the dollar since January. United States The economy is entering a critical test period. After six months of essentially lateral movement, the big question now is whether cumulative deterioration will set in, tipping the nation into a new recession. Crucial, too, at this juncture is the direction that monetary and budget policies will take in a settling of nervous and unsettled financial markets. Increased speculation that the economy is in a slump may be premature. There is no certainty that the small slippage in GNP will continue in light of the lift that will be provided by the tax cuts and the growth in defense spending. The cause of the current softness is essentially Federal Reserve restraint. With that restraint now lessening, there is a good prospect that recessionary tendencies will not cumulate. Fiscal policy, meanwhile, faces its own critical test. Scarcely two months after historic victories in cutting the budget, President Reagan came back with a second slice. The ultimate response in Congress seems unclear. Since mid-July the demand for credit in the United States has been stubbornly strong in the face of high interest rates. The market seems impressed by Chairman Volcker's reaffirmation of the Federal Reserve's commitment to restrain monetary expansion. In addition, the market is increasingly concerned about the impact of the U.S. government's budget deficits and near-term financing requirements on U.S.financial markets. In this environment, interest rates remain high, and the dollar remained strong. Inflation continues at a 10% annual rate