1) Is foreign exchange risk systematic? What are the implications of your answer regarding corporate hedging policy with respect to foreign exchange risk? In your answers make sure to discuss the possibility of divergent views on this issue between management and shareholders.
2) Do you think investors should try to diversify their domestic investment portfolios by including international assets in it? Why/why not? What is the best way to achieve the benefits (if any) of international portfolio diversification without bearing the associated costs?
3) Explain how a financial manager should account for political risk when considering a project in a foreign country. Assume that the financial manager works for a multinational firm with presence in many different countries.
4) HGK, a Thai firm, is considering starting production of high-def TVs in its U.S subsidiary for sale in the U.S. The project has a 4-year life and requires an initial investment of $6,000,000 in equipment. The equipment is to be depreciated (to zero) on a straight line basis and is expected to be sold for a market value of $500,000 at project's end. HGK is expected to produce and sell 100,000 units of its product in the U.S in each year. Variable costs are expected to be $75/unit and fixed costs $1,900,000 per year. The project requires additions to net working capital of 4,000,000 (to be recovered at project's end). HGK assigns a cost of capital of 20% to this project. The corporate tax rate in the U.S. is 39% while in Thailand it is 34%. HGK expects to break even in the US (in US $-terms).The United States imposes no restrictions on the repatriation of funds of any sort. Both Thailand and the U.S. allow a tax credit for taxes paid in the other country.
a. What is the price per unit of HGK's product in the U.S.?
b. Assume that the price of the TVs is $134.59/unit. What is the project's NPV from the Thai parent's point of view? Suppose that the current exchange rate is 20bt/$ and that it is expected to remain constant until the last year of the project (year t=4) when it is expected to be 25Bt/$.
5) Faulpeltz Gmbh. is a German subsidiary of Lazy Ltd., a British MNC. Faulpeltz is considering a 5-year project in Germany that requires an initial investment of 1,360 million Euros (EU). The project will generate cash flows of EU 450 million per year in the years 1 to 4 and EU 575 million at the end of year 5. The required rate of return for projects of similar risk in Germany is 10%, and in the U.K. is 12%. The annual inflation rate in Germany is expected to be 4.5% for the next several years. British (annual) inflation is expected to be 2.5%. The current spot exchange rate is 0.65 £/EU.
a. Calculate the NPV in £-terms from the project's (Faulpeltz Gmbh.) point of view.
b. Calculate the NPV in £-terms from the parent's (Lazy Ltd.) point of view.
c. What is your recommendation to Lazy's managers in terms of whether they should accept or reject the project?
d. Should Lazy's managers try to hedge the EU projected cash flows? Why/why not?
6) At the end of 2011 you bought 25000 shares of a Mexican stock at a price of 220 peso/share. At that time the spot exchange rate was 0.2458$/peso. Nine months later, you sold these shares for 240.5 peso/share. If your annualized US-$ rate of return on that investment was 21.5%, what was the exchange rate when you sold the Mexican shares?
7) Toshiyuki Matsukawa is production manager for Tanaka Chemicals, a Japanese chemical manufacturer operating throughout Asia. He is considering a proposal to build a chemical plant in Thailand to service the growing Southeast Asian market. the project information is as follows:
- The exchange rate is currently S0Bt/¥ = 0.2500 Bt/¥.
- The manufacturing plant will cost Bt 4 million and will take one year to construct. assume the Bt 4 million cost will be paid in full at the end of the year (at t=1).
- The real value of the manufacturing plant is expected to remain at Bt 4 million throughout the life of the project. The plant is to be sold at project's end.
- Production begins in one year (at t=1) with annual; revenues of Bt 1000 million per year (in nominal terms) over the 4-year life of the project. fixed expenses are contractually fixed in nominal terms at Bt 5million each year over the life of the project. Variable costs are 90 percent of gross revenues. assume end-of-year cash flows.
- The plant will be owned by a subsidiary in Thailand and will be depreciated to zero on a straight line basis.
- Taxes are 40% in Thailand.
- annual inflation is expected to be 105 in Thailand and 5% in Japan.
- The required rate of return on similar projects in Thailand is 20%.
- Assume that the international parity conditions hold.
a. Calculate the Thai Bhat (Bt) value of this investment proposal from the local (Thai) point of view.
b. What is the nominal required rate of return for similar projects in Japan?
c. Identify the expected future spot exchange rates for each cash flow.
d. Calculate the yen value of the project from the local and parent perspective. Are the answers equivalent? Why?