SUNWAY UNIVERSITY BUSINESS SCHOOL SAMPLE FINAL EXAMINATION FOR FIN3034 INTERNATIONAL FINANCIAL MANAGEMENT

Transcription

1 SUNWAY UNIVERSITY BUSINESS SCHOOL SAMPLE FINAL EXAMINATION FOR FIN3034 INTERNATIONAL FINANCIAL MANAGEMENT

2 Section A This Section comprises TWO (2) questions. Answer BOTH questions. Question 1 You are the chief financial officer of Lotus Cars Berhad, a multinational company in the automotive business based in Malaysia. The company is considering an expansion into the rapidly developing Eastern European market by investing in an assembly plant in the Czech Republic. After conducting local market research and a personal review, you are convinced that, although the more established brands such as Volkswagen, PSA and Ford are already present, there is demand for its products due to the unique design and affordable prices. The capital expenditure investment in Czech korunas would amount to CZK 240 million or RM 40 million at the current spot rate of CZK6.00/RM. The capital expenditure will be depreciated over ten years by the straight-line method. An additional CZK 90 million will be needed for working capital. You have managed to negotiate a sale of the business to a local private equity firm at the end of the third year at a price, net of tax, equal to the net book value of the capital expenditure. All free cash flow will be repatriated to Malaysia as soon as possible. In evaluating the venture, the Malaysian Ringgit forecasts are shown in the table below. Variable manufacturing costs are expected to be 70% of sales. No additional funds need be invested in the company during the period under consideration. The Czech Republic imposes no restrictions on repatriation of any funds of any sort. The Czech corporate tax rate is 19% and the Malaysian rate is 25%. Both countries allow a tax credit for taxes paid in other countries. You have decided to use 15% as the weighted average cost of capital, and the objective is to maximize present value. Assumptions Spot exchange rate (CZK/RM) Unit demand 5,000 7,000 10,000 Unit sales price (RM) 40,000 45,000 47,000 Fixed cash operating expenses (RM) 1,000,000 1,030,000 1,060,000 (a) Determine whether Lotus Cars Berhad should undertake the investment, showing all calculations (b) Capital budgeting for a foreign project such as the one identified above is considerably more complex than a domestic project. Critically discuss the factors that cause this complexity 2

3 Question 2 On May 1st, Larkin Hydraulics Sdn Bhd, a wholly owned subsidiary of Power Products Berhad (Malaysia), sold a 12 megawatt compression turbine to Rebecke- Terwilleger Company of the Netherlands for 4,000,000, payable 2,000,000 on August 1st and 2,000,000 on November 1st. Larkin Hydraulics derived its price quote of 4,000,000 on April 1st by dividing its normal Malaysian Ringgit sales price of RM 17,280,000 by the then current spot rate of RM4.320/. By the time the order was received and booked on May 1st, the euro had strengthened to RM4.400/, so the sale was in fact worth 4,000,000 x RM4.400/ = RM 17,600,000. Larkin Hydraulics had already gained an extra RM 320,000 from favorable exchange rate movements. Nevertheless Larkin Hydraulics's Finance Director now wondered if the firm should undertake active currency risk management by hedging against a reversal of the recent trend of the euro. Following some enquiries, he identified the following four approaches: 1. Hedge in the forward market. The 3-month forward exchange quote was RM4.406/ and the 6-month forward quote was RM4.413/. 2. Hedge in the money market. Larkin Hydraulics could borrow euros from the Frankfurt branch of its bank at 8.00% per annum. 3. Hedge with foreign currency options. August put options were available at a strike price of RM4.400/ for a premium of 2.0% per contract, and November put options were available at RM4.400/ for a premium of 1.2%. August call options at RM4.400/ could be purchased for a premium of 3.0%, and November call options at RM4.400/ were available at a 2.6% premium. 4. Do nothing. Larkin Hydraulics could wait until the sales proceeds were received in August and November, hope the recent strengthening of the euro would continue, and sell the euros received for ringgit in the spot market. Larkin Hydraulics estimates the cost of equity capital to be 12% per annum. As a small firm, Larkin Hydraulics is unable to raise funds with long-term debt. Malaysian T-bills yield 3.6% per annum. (a) Based on the above alternatives, recommend the appropriate hedging approach to be adopted by Larkin Hydraulics Sdn Bhd, showing all calculations (b) Critically discuss the arguments in favour of and against Larkin Hydraulics Sdn Bhd undertaking active currency risk management 3

4 Section B This Section comprises THREE (3) questions, Answer any TWO (2) questions Question 3 Sime Darby Berhad is a Malaysian plantation company founded 52 years ago and is one of the world s largest exporters of palm oil. Through acquisitions, the Company has grown into a conglomerate with subsidiaries in Europe and the US. As CFO of the US subsidiary, Sime Darby (US) Incorporated, you are currently planning to raise US$10 million or the equivalent foreign currency for four years to finance its expansion. After conducting extensive research you have narrowed your choices to the following: (a) Sell Japanese yen bonds at par yielding 2% per annum. The current exchange rate is 106/$, and the yen is expected to strengthen against the dollar by 2% per annum. (b) Sell euro-denominated bonds at par with a yield 6% per annum. The current exchange rate is $1.1960/, and the euro is expected to weaken against the dollar by 2% per annum. (c) Sell U.S. dollar bonds at par with a yield of 4% per annum For all the above alternatives, you have assumed that interest is payable once per year, at the end of the year. (a) Identify the appropriate course of action you would recommend for Sime Darby (US) Incorporated, showing all calculations. (b) Critically discuss whether Sime Darby (US) Incorporated should conform to the capital structure norms of the host country, or to the norms of the parent country in Malaysia. 4

5 Question 4 Bangkok Instruments Ltd. is the Thai subsidiary of a Malaysian seismic instrument manufacturer. Bangkok Instruments manufactures the instruments primarily for the oil and gas industry globally, though with recent commodity price increases of all kinds -- including copper -- its business has begun to grow rapidly. Sales are primarily to multinational companies based in South East Asia and Europe. Bangkok Instruments' balance sheet in Thai Baht (B) as of March 31 is as follows. Bangkok Instruments Ltd Statement of financial position as at March 31 Assets B 000 Liabilities & Net worth B 000 Cash 24,000 Accounts payable 18,000 Accounts Receivable 36,000 Bank loans 60,000 Inventory 48,000 Common stock 18,000 Net plant & equipment 60,000 Retained earnings 72, , ,000 Exchange rates for translating Bangkok Instruments balance sheet into Ringgit are as follows: B11.00/RM April 1 exchange rate after devaluation. B10.00/RM March 31 exchange rate, before devaluation. All inventories were acquired at this rate. B9.00/RM Historic exchange rate at which plant and equipment were acquired and common stock was issued The Thai baht depreciated in value from B10.00/RM to B11.00/RM between March 31st and April 1st. There was no change in balance sheet accounts during these two days. (a) Calculate the gain or loss from translation by both the current rate method and the temporal method and explain the translation gain or loss in terms of changes in the value of exposed accounts. As part of a group wide restructuring, the parent Company in Malaysia is considering a proposal from a Thai private equity firm to acquire Bangkok Instruments Ltd and continue to manufacture the products under a licensing agreement. (b) Critically discuss the impact of continuing the business under the proposed licensing arrangement. 5

6 Question 5 You are the financial controller of HD Products Berhad, a manufacturer of car stereo systems headquartered in Shah Alam, Malaysia. The company exports its products to Brazil, whose currency, the reais (symbol R$) has been trading at R$0.70/RM. Exports to Brazil are currently 50,000 units per year at the reais equivalent of RM200 each. A strong rumor exists that the reais will be devalued to R$0.80/RM within two weeks by the Brazilian government. Accepting this information as reliable, HD Products faces a pricing decision which must be made before any actual devaluation: HD Products may either (1) maintain the same reais price and receive lower Ringgit, in which case Brazilian volume will not change, or (2) maintain the same Ringgit price, raise the reais price in Brazil to compensate for the devaluation, and experience a 20% drop in volume. Direct costs in Malaysia are 60% of the sales price. Required (a) Determine the short-run (one-year) implication of each pricing strategy, showing all calculations. (7 marks) You have been informed that HD Products patent expires at the end of six years and due to the difficult market conditions, the Company has decided not to continue exporting to Brazil after its expiry. The Marketing Department believes that if the Company maintains the same price in reais as a permanent policy, volume will increase at 10% per annum for six years. If HD Products raises the price in reais so as to maintain its Ringgit price, volume will increase at only 3 % per annum for six years, starting from the lower initial base of 40,000 units. The Company s weighted average cost of capital is 12%. Direct costs in Malaysia are not expected to change much due to long term component supply contracts. After the reais is devalued to R$0.80/RM, no further devaluation is expected. Required (b) Provide recommendations for an appropriate pricing policy for the Company, showing all calculations (8 marks) (c) Critically discuss how multinational companies such as HD Products can manage its operating and transaction exposures by adopting proactive policies that offset anticipated foreign exchange risks. 6