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Blades Inc. Case, Assessment of Risk Exposure, (Jeff Madura, International Financial Management)

Blades Inc. Case, Assessment of Risk Exposure, (Jeff Madura, International Financial Management)

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07/05/2015

Case Summary

Blades Inc. is a U.S based company that has been incorporated in the United States for three years. Blades
is a relatively small company, with total assets of only $200 million. The company produces a sinle type
of product, roller blades. Blades Inc. e!ports to Thailand and a retailer in U" to supplement declinin
U.S. sales. Blades Inc. has suppliers in US and Thailand. #ll e!ports and imports denominated in
respective forein currency. $ecision to e!port to Thailand was supported as Thailand is one of the fastest
rowin economies. There was an importer committin itself to annual purchase of %&0,000 pairs of
Blades 'Speedos(. The commitment bean last year and will last another 2 years and has renewal option.
#s committed, Blades is sellin its roller blades for ),*+) baht per pair ,appro!imately $%00 at current
e!chane rate- instead of usual $%20 per pair. #lthouh discounted price but it still constitutes a
considerable mar.up. #s there were no interested importers for such commitment in #sia, it was decisive
factor to e!port to Thailand. #lthouh Ben /old, 012 of Blades, believes that mar.et for sports products
is rowin is #sia, Blades has started e!portin to 3os 4td. a British retailer. 3os has a commitment
with Blades to purchase 200,000 pairs of Speedos at &0 pounds per pair. In near future, Blades forecasted
to import supplies from Thailand for producin &0,000 pairs of Speedos, at a cost of 5,000 baht per pair
of Speedos. Blades6 financial analyst pointed out the recent economic condition of #sian countries,
includin Thailand which may cause substantial depreciation of Thai Baht and Thai importer may not
renew commitment. But Ben /olt, 012, bein optimistic, has no doubt about renewal of the contract by
Thai importer. 1inancial analyst thin.s, Ben /olt is inorin the future of Blades after renewal is made
and effect of hih level of inflation. 1ollowin information is available7
• 1orecasted sales89 in the US#, *20,000 pairs:$%20 per pair. In Thailand, %&0,000 pairs:),*+)
baht a pair. In the U",200,000 pairs:&0 pounds per par.
• 0ost of oods sold for &0,000 pairs incurred in Thailand and remainin in US#:$;0 per pair
• 1i!ed cost $2,000,000 and variable cost is %%< of US sales.
• 0urrent spot rate of baht is $.022 and for pound is $%.*0
Scenario =ffect on baht #verae value of baht #verae value of
pound
% >o chane $.00220 $%.*50
2 *< depreciation $.020+ $%.)&*
5 %0< depreciation $.0%+& $%.*00
• >o debt in capital structure but additional funds can be borrowed in Thailand if a subsidiary is
established
1. How will Blades be negatively affected by the high level of inflation in Thailand if the Thai
customer renews its commitment for another three years?
#s business becomes increasinly lobal, the volatility of e!chane rates become more important,
even for a purely domestic firm operatin in a lobal mar.et. 1irms have to pay more attention to
e!chane rate ris.. 0hanes in e!chane rates e!pose a ?>0 to currency ris.. Inflation has a direct
relation to e!chane rates and these chanes affects a firm6s competitiveness, increases or decreases
sales revenue, affects the cost of oods sold, input prices, operatin profits, mar.et share, stoc. price,
mar.et value, etc. all these are referred to as a firm6s economic e!posure.
#s with Blades Inc, havin the parent operation in US# and with contractual sales in both U" and
Thailand, it can easily be assumed that the economic conditions of the countries of operation will
have some effect on Blades Inc. the hih level of inflation in Thailand is our ma@or concern.
#ccordin to the contract, Blades Inc. US# sells %&0,000 pairs of Blades 'Speedos( annually to the
importer. #s per the contract, Blades is sellin the roller blades for )*+) Baht which is appro!imately
$%00 at current e!chane rates. But the usual price is $ %20. Stipulatin that the contract is renewed
for another three years, Blades Inc. will have to sell the roller blades as )*+) Baht or $%00. This
means that the hih level of inflation in Thailand will have no impact on the cash inflow from that
subsidiary.
Blades Inc, also purchases some supplies from Thailand. Therefore, the cost of oods sold incurred in
Thailand will be sub@ect to the hih level of inflation. This sinifies that the cash outflow will
increase for Thailand.
#lso, the inflation will have some effect on the Thai baht, further depreciatin its value. This will
reduce the dollars received from baht denominated sales to Thailand.
#ccordin to the iven circumstances the future e!penses of Blades Inc are more sensitive than future
revenue to the possible values of a Thai baht. Bein in the contract, Blades has no control over the
sensitivity of forein revenue. =!tendin the contract further for three years durin an inflatin
economy will further increase the economic e!posure of Blades Inc.
2. Holt believes that the Thai importer will renew its commitment in two years. o you thin! his
assessment is correct? "hy or why not? #lso$ assume that the Thai economy returns to the high
growth level that e%isted prior to the recent unfavorable economic events. &nder this
assumption$ how li!ely is it that the Thai importer will renew its commitment in two years?
To ma.e a correct assumption on the decision of whether the importer will renew the contract or not
we need to view it from the perspective of the importer as well as that of Blades Inc. 0urrently the
contract has one throuh the initial year and two more years remain until its e!piration. Ae need to
analyBe the potentials of the contract if it is to be renewed by the importer.
Cenewin the contract after the e!piration period has both advantaes and disadvantaes for the
importer. If the contract is renewed, the importer will have some cost benefit over the price of the
Speedos roller blades. #s the contract specifies, the importer will be able to import the roller blades at
the price of )*+) baht even when the Thai economy is facin hih level of inflation. So this proves as
an advantae for the importer allowin him to import at a secured priceD as the cost incurred by the
importer is denominated in Thai baht which is not sub@ect to the hih level of inflation. But the
contract renewal may also prove as a disadvantae for the importer. If the Thai economy continues
throuh hih level of inflation after the contract is renewed, the importer will be able to import
products at the predetermined rate, but the hih inflation may provo.e consumers in Thailand to
reduce their spendin on leisure products. So the inflation in Thailand may lead the Thai sales
towards a steady decline. Thus the Thai firm may not be able to sell all of the products it has
purchased from Blades.
0onsiderin the above facts, we can assume that the importer will renew the contracts only if the
decline in sales is offset by the advantae of cost incurred. Cenewin the contract will provide benefit
to the importer over its competitors as they are prone to the hih level of inflation. So the importer
can attain a benefit over its competitors in the cost department. =!tendin the contract will also
reduce the economic e!posure of the importer even durin inflation periods. But this will occur only
when the costs incurred by the importer in Thai baht is offset by its revenue.
#ssumin that the Thai economy returns to a hih rowth level, there is li.elihood of the Thai
customer renewin its commitment. This is because it can be reasonably certain that it will sell all of
the products it has committed itself to purchase from Blades. 1urthermore, the costs it incurs are still
not sub@ect to the hih level of inflation prevailin in Thailand.
'. (or each of the three possible values of the Thai baht and the British pound$ use a spreadsheet
to construct a pro forma income statement for the ne%t year. Briefly comment on the level of
Blades) economic e%posure.
Blades, Inc. does not appear to be sub@ect to a hih level of economic e!posure based on the analysis.
If Thai baht and British pound depreciate by * percent then U" and Thai sales reduce when converted
into US dollars, as a result total sales decreases. /owever, cost of oods sold also decreases when
baht depreciates but this reduction can not outperform the reduction in sales which results in lower
earnin before ta!es.
>evertheless, a depreciation of the Thai baht by %0 percent to an averae level of $.0%+& over the
year would decrease its earnins before ta!es by appro!imately * percent. Thus, Blades, Inc. is
sub@ect to some economic e!posure.
T/B8$0.0220 T/B8$0.020+ T/B8$0.0%+&
BE8$%.*50 BE8$%.)&* BE8$%.*00
Sales
,%- U.S. ,*20,000 units F $%20Gpair- $ H2,)00,000 $ H2,)00,000 $ H2,)00,000
,2- Thai ,%&0,000 units F T/B),*+) F
=!chane Cate-
$ %&,%+2,2)0 $ %;,2&2,H2& $ %H,5;5,0%H
,5- British ,200,000 units F &0 pounds F
=!chane Cate-
$ 2),)&0,000 $ 25,;H0,000 $ 2),000,000
,)- Total $%0*,0;2,2)0 $%05,))2,H2& $%02,;;5,0%H
0ost of oods sold7
,*- U.S. ,I+00,000 J &0,000K units F $;0- $ *;,)00,000 $ *;,)00,000 $ *;,)00,000
,H- Thai ,&0,000 units F T/B5,000 F
=!chane Cate-
$ *,2&0,000 $ *,0%H,000 $ ),;*2,000
,;- Total $ H2,H&0,000 $ H2,)%H,000 $ H2,%*2,000
,&- Lross profit $ )2,5+2,2)0 $ )%,02H,H2& $ )0,H2%,0%H
2peratin =!penses7
,+- U.S.7 1i!ed $ 2,000,000 $ 2,000,000 $ 2,000,000
,%0- U.S.7 Mariable ,%%< of U.S. sales- $ H,&H),000 $ H,&H),000 $ H,&H),000
,%%- Total $ &,&H),000 $ &,&H),000 $ &,&H),000
,%2- =arnins before ta!es * ''$+2,$2-. * '2$1/2$/2, * '1$0+0$.1/
1arnings before ta%es reduced by2
< 0; . ) %00 N
2)0 , *2& , 55 $
H2& , %H2 , 52 $ 2)0 , *2& , 55 $
on depreciati percent * in < =

= ∆
< 2& . * %00 N
2)0 , *2& , 55 $
0%H , ;*; , 5% $ 2)0 , *2& , 55 $
on depreciati percent %0 in < =

= ∆
In this scenario,

=arnins before ta!es reduced by appro!imately ) percent since both baht and pound have
depreciated aainst US$

=arnins before ta!es reduced by appro!imately * percent since %0 percent depreciation in baht
has outperformed the appreciation of pound aainst US$.
So, we can conclude that, since the cash flows of Blades inc. are affected by e!chane rate fluctuations,
Blades Inc. certainly have economic e!posure but to a limited e!tent.
-. 3ow repeat your analysis in 4uestion ' but assume that the British pound and the Thai baht are
perfectly correlated. (or e%ample$ if the baht depreciates by + percent$ the pound will also
depreciate by + percent. &nder this assumption$ is Blades sub5ect to a greater degree of
economic e%posure? "hy or why not?
If the British pound and the Thai baht are perfectly correlated, as a result Blades6 level of economic
e!posure increases. This is because Blades enerates inflows in both pounds and baht. So if, the
pound and baht tend to appreciate then more cash will flow in to Blades in US$ and if these
currencies depreciate aainst US$ then less cash will flow in to company causin intense economic
e!posure.
T/B8$0.0220 T/B8$0.020+ T/B8$0.0%+&
BE8$%.*0 BE8$%.)2* BE8$%.5*0
Sales
,%- U.S. ,*20,000 units F $%20Gpair- $ H2,)00,000 $ H2,)00,000 $ H2,)00,000
,2- Thai ,%&0,000 units F T/B),*+) F
=!chane Cate-
$ %&,%+2,2)0 $ %;,2&2,H2& $ %H,5;5,0%H
,5- British ,200,000 units F &0 pounds F
=!chane Cate-
$ 2),000,000 $ 22,&00,000 $ 2%,H00,000
,)- Total $ %0),*+2,2)0 $ %02,)&2,H2& $ %00,5;5,0%H
0ost of oods sold7
,*- U.S. ,I+00,000 J &0,000K units F $;0- $ *;,)00,000 $ *;,)00,000 $ *;,)00,000
,H- Thai ,&0,000 units F T/B5,000 F
=!chane Cate-
$ *,2&0,000 $ *,0%H,000 $ ),;*2,000
,;- Total $ H2,H&0,000 $ H2,)%H,000 $ H2,%*2,000
,&- Lross profit $ )%,+%2,2)0 $ )0,0HH,H2& $ 5&,22%,0%H
2peratin =!penses7
,+- U.S.7 1i!ed $ 2,000,000 $ 2,000,000 $ 2,000,000
,%0- U.S.7 Mariable ,%%< of U.S. sales- $ H,&H),000 $ H,&H),000 $ H,&H),000
,%%- Total $ &,&H),000 $ &,&H),000 $ &,&H),000
,%2- =arnins before ta!es * ''$.-,$2-. * '1$2.2$/2, * 26$'+0$.1/
1arnings before ta%es reduced by2
< %; . %% %00 N
2)0 , 0)& , 55 $
0%H , 5*; , 2+ $ 2)0 , 0)& , 55 $
on depreciati percent %0 in < =

= ∆
< *& . * %00 N
2)0 , 0)& , 55 $
H2& , 202 , 5% $ 2)0 , 0)& , 55 $
on depreciati percent * in < =

= ∆
Under this scenario,
• # depreciation of the pound and the baht by * percent would reduce Blades6 earnins before
ta!es by appro!imately H percent.
• # depreciation of the pound and the baht by %0 percent would reduce Blades6 earnins before
ta!es by appro!imately %% percent.
#s a result, Blades6 sensitivity to economic e!posure increases sinificantly. In depth, depreciation in one
currency causin less cash flow for Blades Inc. would show more adverse effect on Blades alon with
depreciation in another currency. So, economic e!posure ris. would be more and in addition, both
currencies fluctuate by same deree. If Thai Baht depreciate, then cash flow inflow from Thailand would
be affected and same applies for U" business if British pound depreciates. /ere, Blades will have fewer
earnins from both U" and Thailand whenever pound and baht depreciate aainst US$.
+. Based on your answers to the previous three 4uestions$ what actions could Blades ta!e to
reduce its level of economic e%posure to Thailand?
=conomic e!posure can be manaed by balancin the sensitivity of revenue and e!penses to
e!chane rate fluctuations. To accomplish this, however, the firm must first reconiBe how its
revenue and e!penses are affected by e!chane rate fluctuations. 1or some firms, revenue is more
susceptible. These firms are most concerned that their home currency will appreciate aainst forein
currencies since the unfavorable effects on revenue will more than offset the favorable effects on
e!penses. 0onversely, firms whose e!penses are more sensitive to e!chane rates than their revenue
are most concerned that their home currency will depreciate aainst forein currencies. Ahen firms
reduce their economic e!posure, they reduce not only these unfavorable effects but also the favorable
effects if the home currency value moves in the opposite direction.
There are several actions Blades could ta.e. The analysis above illustrates that economic e!posure
can be reduced by the followin strateies7
• iversification of 7nternational Business2 0onductin its international business in countries
whose currencies are not hihly correlated. Thus, Blades could be e!portin to or importin
from other countries besides Thailand and the United "indom.
o 8imitations2 2ther macro economic variables such as inflation, interest rates,
competition, mar.et condition, overnment reulations may have their individual
effect on sales and the ?>06s value.
• (inancing with (oreign (unds2 #nother action Blades could ta.e is to borrow in baht,
which would reduce the number of baht that would have to be converted to dollars, as the
baht receivables could be used to repay to bahtOdenominated loans. The borrowed funds
could then be converted to dollars to pay for U.S. supplies.
o 8imitations2 The hih level of interest rates may not ma.e this a feasible alternative.
• 9urchasing (oreign Supplies2 To further reduce its economic e!posure, Blades could also
buy more supplies from Thailand instead of the U.S. in order to create more cash outflows in
baht. This would further reduce the level of economic e!posure, as more baht revenues could
be used to buy Thai supplies.
o 8imitation2 The success of this approach depends on the impact of the hih level of
inflation in Thailand on mar.et prices for the imported components.

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