Problem 11.3 Seattle Scientific, Inc.

Josh Miller is chief financial officer of a medium-sized Seattle-based medical device manufacturer. The
companys annual sales of $40 million have been growing rapidly, and working capital financing is a common
source of concern. He has recently been approached by one of his major Japanese customers, Yokasa, with a
new payment proposal. Yokasa typically orders 12,500,000 in product every other month and pays in Japanese
yen. The current payment terms extended by Seattle are 30 days, with no discounts given for early or cash
payment. Yokasa has suggested that it would be willing to pay in cash in Japanese yen if it was given a 4.5%
discount on the purchase price. Josh Miller gathered the following quotes from his bank on current spot and
forward exchange rates, and estimated Yokasas cost of capital.
Assumptions
Seattle's 30-day account receivable, Japanese yen
Spot rate, /$
30-day forward rate, /$
90-day forward rate, /$
180-day forward rate, /$
Yokasa's WACC
Seattle Scientific's WACC
Desired discount on purchase price by Yokasa

Values
12,500,000
111.40
111.00
110.40
109.20
8.850%
9.200%
4.500%

Josh Miller should compare two basic alternatives, both of which eliminate the currency risk.
1. Allow the discount and receive payment in Japanese yen in cash
Account recievable (yen)
Discount for cash payment up-front (4.500%)
Amount paid in cash net of discount
Current spot rate
Amount received in U.S. dollars by Seattle Scientific

12,500,000
(562,500)
11,937,500

111.40
107,158.89

12,500,000
111.00
112,612.61

0.9924
111,755.82

2. Not offer any discounts for early payment and cover exposure with forwards
Account receivable (yen)
30-day forward rate
Amount received in cash in dollars, in 30 days
Discount factor for 30 days @ Seattle's WACC
Present value of dollar cash received

Josh Miller should politely decline Yokasa's offer to pay cash in exchange for the requested discount.

Problem 11.11 PanAmerican Travel

PanAmerican Travel, a Honolulu, Hawaii based 100% privately owned travel company has signed an agreement to acquire a
50% ownership share of Taipei Travel, a Taiwan based privately owned travel agency specializing in servicing inbound
customers from the United States and Canada. The acquisition price is 7 million Taiwan dollars (T$ 7,000,000) payable in
cash in 3 months.
Susan Takaga, PanAmericans owner, believes the Taiwan dollar will either remain stable or decline a little over the next 3
months. At the present spot rate of T$35/$, the amount of cash required is only $200,000 but even this relatively modest
amount will need to be borrowed personally by Susan Takaga. Taiwanese interest-bearing deposits by non-residents are
regulated by the government, and are currently set at 1.5% per year. She has a credit line with Bank of Hawaii for $200,000
with a current borrowing interest rate of 8% per year. She does not believe that she can calculate a credible weighted average
cost of capital since she has no stock outstanding and her competitors are all also privately-owned without disclosure of their
financial results. Since the acquisition would use up all her available credit, she wonders if she should hedge this transaction
exposure.
Assumptions
Acquisition price & 3-month A/P, NewTaiwan dollars (T$)
Spot rate (T$/$)
3-month forward rate (T$/$)
3-month Taiwan dollar deposit rate
3-month dollar borrowing rate
3-month call option on T$
Susan Takaga's credit line with Bank of Hawaii

Evaluation of Alternatives

Values
7,000,000
33.40
32.40
1.500%
8.000%
not available
200,000
Cost

Certainty

1. Do Nothing -- Wait 3 months and buy T$ spot

If spot rate is the same as current spot rate

209,580.84

Risky

If spot rate is the same as 3-month forward rate

216,049.38

Risky

216,049.38

Certain

Although this would do nothing to cover the currency risk,

there would be no required payment or borrowing for 3 -months.
2. Buy T$ forward 3-months
Assured cost of T$ at 3-month forward rate
The purchase of a forward contract would not require any cash
up-front, but the Bank of Hawaii would reduce her available credit
line by the amount of the forward. This is a non-cash expense.
3. Money Market Hedge: Exchanging US$ for T$ now, depositing for 3-months until payment
Acquisition price in T$ needed in 3-months
Discounted back 3-months at T$ deposit rate
Amount of NT$ needed now for deposit
Spot rate, T$/$
US$ needed now for exchange
US$ carry-forward rate (3-month dollar borrowing rate)
Carry-forward factor of US$ for 3-month period
Total cost in US$ of settling A/P in 3-months with
Money Market Hedge

7,000,000
0.9963
6,973,848
33.40
208,797.85

8.000%
1.0200
212,973.80

Certain

The currency risk is eliminated, but since Susan Takaga would have to exchange the money up-front, it would require her to
borrow the money, increasing her debt outstanding for the entire 3 months.
Discussion.
This is a difficult decision. The forward contract appears to be the preferable choice, protecting her against an appreciating T$,
and creating a certain cash purchase payment. The problem, however, will be whether the Bank of Hawaii will allow her to
purchase a forward for the full $216,049.38, which is slightly above her credit line currently in-place. If her relatonship is
good with the bank, they most likely would increase her line sufficiently to allow the forward contract.