FIN 536, 13S

Fin 536 International Corporate Finance Project: Operating Exposure Analysis Name: ______________________________ Due date: April 3, 2013

XXX, Inc. is an U.S.-based MNE located in Phoenix, Arizona. XXX has a 100%-owned manufacturing subsidiary in Germany. Currently (T = 0), XXX Germany has an annual sale volume of 1,200,000 units. It sells 500,000 units within Europe and exports the rest of its products to Non-European countries. All the sales are invoiced in s. The companys products are manufactured in Germany with local materials. It is believed that XXX Germany can increase or decrease production volume without any significant changes in costs. The income tax is 30% for XXX Germany. The average collection period is 90 days and inventory is equal to 20% of the direct cost of goods sold. Assume no additional capital expenditure is required and no terminal value exists. In this project, you are required to analyze the issue of operating exposure and evaluate the projects NPV corresponding to the changes in real exchange rate. The following information is available. Conduct your analysis using the worksheet templates in 536-4a.xls. Inflation Forecast: o Inflation rate is 4% per year in Germany for the next 5 years. o Inflation rate is 3% per year in U.S. for the next 5 years. o Exchange rate at T = 0 is 1.4 $/. Revenues: o Sales volume at T= 0: 500,000 in Europe and 700,000 in the rest of the world. o Sales growth for the next 5 years: 6%, 6%, 6%, 6%, 6% in Europe and 4%, 4%, 4%, 4%, 4% in the Non-European markets. o Sale price at T = 0: 21 in Europe and in Non-European markets. Costs: o Cost of goods sold per unit at T = 0 is 16 and expected to increase at the German inflation rate. o Fixed cost of sales is 1,350,000 at T = 0 and grows at the German inflation rate. o Depreciation is assumed to be 500,000 at T = 0 and remains constant for the next 5 years. Working Capital Requirement: o The average collection period is 90 days. o Inventory is equal to 20% of the direct cost of goods sold. o The increase in working capital will be financed by operating cash flow (OCF). Assume no additional capital expenditure is required and no terminal value exists. Tax rate is assumed constant at 30%. Dollar WACC is assumed constant at 18%.

FIN 536 - SU

FIN 536, 13S

I.

Forecast the cashflows from T = 1 to 5 and build a discounted cash flow model to value XXX Germanys project. Prepare a BASE CASE analysis (Exhibit 1) based on the following assumptions. Use PPP exchange rate as the expected future exchange rate. European Market 100% pass-through Pricing Strategy; Sales growth from T = 1 to 5: 6%, 6%, 6%, 6%, and 6%. Non-European Market 100% pass-through Pricing Strategy; Sales growth from T = 1 to 5: 4%, 4%, 4%, 4%, and 4%.

II. Your firm strongly believes the following exchange rate forecasts: Year 1 2 3 4 5 S 1.375 $/ 1.368 $/ 1.351 $/ 1.342 $/ 1.200 $/ Forecast the cashflows from T = 1 to 5 and build a discounted cash flow model to value XXX Germanys project. Conduct a Scenario Analysis (Exhibit 2) based on the following assumptions. European Market 0% pass-through Pricing Strategy; Sales growth from T = 1 to 5: 45%, 45%, 45%, 45%, and 45%. Non-European Market 0% pass-through Pricing Strategy; Sales growth from T = 1 to 5: 30%, 30%, 30%, 30%, and 30%. III. Your firm strongly believes the following exchange rate forecasts: Year 1 2 3 4 5 S 1.375 $/ 1.368 $/ 1.351 $/ 1.342 $/ 1.200 $/ Forecast the cashflows from T = 1 to 5 and build a discounted cash flow model to value XXX Germanys project. Conduct a Scenario Analysis (Exhibit 3) based on the following assumptions. European Market 50% pass-through Pricing Strategy; Sales growth from T = 1 to 5: -20%, -20%, -20%, -20%, and -20%. Non-European Market 50% pass-through Pricing Strategy; Sales growth from T = 1 to 5: -25%, -25%, -25%, -25%, and -25%. IV. Your firm strongly believes the following exchange rate forecasts: Year 1 2 3 4 5 S 1.375 $/ 1.368 $/ 1.351 $/ 1.342 $/ 1.200 $/ Forecast the cashflows from T = 1 to 5 and build a discounted cash flow model to value XXX Germanys project. Conduct a Scenario Analysis (Exhibit 4) based on the following assumptions. European Market 35% pass-through Pricing Strategy; Sales growth from T = 1 to 5: 30%, 30%, 30%, 30%, and 30%. Non-European Market 100% pass-through Pricing Strategy; Sales growth from T = 1 to 5: -45%, -45%, -45%, -45%, and -45%.

FIN 536 - SU