You are on page 1of 6

UKFF3313 Strategic Financial Management (May 2011)

UNIVERSITI TUNKU ABDUL RAHMAN FACULTY OF ACCOUNTANCY AND MANAGEMENT

ACADEMIC YEAR 2011 BACHELOR OF ACCOUNTING (HONS) BACHELOR OF ECONOMICS (HONS) GLOBAL ECONOMICS YEAR 3 TRIMESTER 2

ASSIGNMENT (Question)

This is a group assignment, which will consist of a maximum of five students. The assignment must be: Typewritten (Times New Roman font size 12) Printed on A4 sized paper Such that is contains: - Cover page - Table for assessment and marks allocation - Table of content - Bibliography - Appendix Mode of referencing: Students are advised to incorporate proper academic modes of referencing. The normally acceptable mode of academic referencing is the American Psychological Association (APA) system Each group will submit the group assignment by Monday, 25 July 2011, before 12.00 pm Both questions to be attempted. Question 1: The evolution of financial derivative instruments means that each new derivative is an improvement on its predecessor. Assume that you are a consultant to a Multinational Company and that the management of the company concerned has approached you to provide advice on the following: a) What constitute the four categories of derivative instruments? 2 marks b) What is(are) the characteristic(s) of each category of derivative instrument? 12 marks c) What is(are) the operational advantage(s) of each category of derivative instrument? 20 marks You are to provide your answer in a Memorandum format 2 marks

UKFF3313 Strategic Financial Management (May 2011)

This question serves to test students on their appreciation of the different types of basic derivative financial instruments that exist, the characteristics of each derivative instrument, and the advantages / disadvantages of each derivative instrument concerned.

Question 2: South Business Co. Foreign Direct Investment This case is intended to illustrate that the value of an international project is sensitive to various types of input. It is also intended to show how a computer spreadsheet format can facilitate capital budgeting decisions that involve uncertainty. This case can be performed using an electronic spreadsheet such as Excel. The use of a computer spreadsheet will significantly reduce the time needed to complete this case. All workings and computer printouts to be included the appendices of the assignment South Business Co is considering establishing a subsidiary to manufacture clothing in Singapore. Its sales would be invoiced in Singapore dollars (S$). It has forecasted net cash flows of the subsidiary as follows: [You are given several scenarios of cash flows; students would need to consult the lecturer for the grouping of cash flows to be allocated other scenarios are included on page 4] Scenario 1 Year 1 2 3 4 5 6

Net cash flows to subsidiary S$16,000,000 20,000,000 28,000,000 32,000,000 32,000,000 32,000,000

These cash flows do not include financing costs (interest expenses) on any funds borrowed in Singapore. South Business Co also expects to receive S$60 million after taxes as a result of selling the subsidiary at the end of Year 6. Assume that there will not be any withholding taxes imposed on this amount. The exchange rate of the Singapore dollar is forecasted as follows, based on 3 possible scenarios of economic conditions: End of year 1 2 Scenario 1: somewhat stable S$ 0.50 0.51 Scenario 2: weak S$ 0.49 0.46 Scenario 3: strong S$ 0.52 0.55

UKFF3313 Strategic Financial Management (May 2011)

3 4 5 6

0.48 0.50 0.52 0.48

0.45 0.43 0.43 0.41

0.59 0.64 0.67 0.71

The probability of each scenario is shown below Somewhat stable S$ 60% Weak S$ 30% Strong S$ 10%

Probability

50% of the net cash flows to the subsidiary would be remitted to the parent, while the remaining 50% would be reinvested to support ongoing operations at the subsidiary. South Business Co anticipates a 10% withholding tax on funds remitted to the United States, being the country of the parent company. The initial investment (including investment in working capital) by South Business Co in the subsidiary would be S$80 million. Any investment in working capital (such as accounts receivable, inventory etc) is to be assumed by the buyer in Year 6. The expected salvage value has already been accounted for this transfer of working capital to the buyer in Year 6. The initial investment could be financed completely by the parent ($40 million, converted at the present exchange rate of $0.50 per Singapore dollar to achieve S$80 million). South Business Co will go forward with its intentions to build the subsidiary only if it expects to achieve a return on its capital of 18% or more The parent company is considering an alternative financing arrangement. With this arrangement, the parent would provide $20 million (S$40 million), which means that the subsidiary would need to borrow S$40 million. Under this scenario, the subsidiary would obtain a 20-year loan and pay interest on the loan each year. The interest payments are S$3.2 million per year. In addition, the forecasted proceeds to be received from selling the subsidiary (after taxes) at the end of 6 years would be S$40 million (the forecast of proceeds is revised downward here because the equity investment of the subsidiary is less; the buyer would be assuming more debt if part of the initial investment in the subsidiary were supported by local bank loans). Assume the parents required rate of return would still be 18%. Required: a) Which of the 2 financing arrangements would you recommend for the parent? Assess the forecasted NPV for each exchange rate scenario to compare the 2 financing arrangements and substantiate your recommendation 30 marks b) In part a) above, an alternative financing arrangement of partial financing by the subsidiary was considered, with an assumption that the required rate of return by the parent would not be affected. Is there any reason why the parents required rate of return might increase when using this financing arrangement? Explain. How would you revise the analysis in part a) under this situation? Are there other alternative method(s) of computing discount rate? Students to take note: This question requires discussion 5 marks c) Would you recommend that South Business Co establish the subsidiary even if the withholding tax is 20%? 15 marks

UKFF3313 Strategic Financial Management (May 2011)

d) Assume that there is some concern about the economic conditions in Singapore, which would cause a reduction in the net cash flows to the subsidiary. Explain how Excel could be used to reevaluate the project based on alternative cash flow scenarios. That is, how can this form of country risk be incorporated into the capital budgeting decision? Students to take note: This question requires discussion 5 marks e) Assume that South Business Co does implement the project, investing $20 million of its own funds with the remainder borrowed by the subsidiary. Two years later, a US-based corporation notifies South Business Co that it would like to purchase the subsidiary. Assume that the exchange rate forecasts for the somewhat stable scenario are appropriate for Year 3 through 6. Also, assume that the other information already provided on net cash flows, financing costs, the 10% withholding tax, the salvage value and the parent companys required rate of return is still appropriate. What would be the minimum dollar price (after taxes) that South Business Co should receive to divest the subsidiary? Substantiate your opinion
10 marks Scenario 2

Year 1 2 3 4 5 6
Scenario 3

Net cash flows to subsidiary S$18,000,000 20,000,000 35,000,000 36,000,000 37,000,000 38,000,000

Year 1 2 3 4 5 6
Scenario 4

Net cash flows to subsidiary S$18,500,000 22,500,000 26,800,000 39,000,000 42,000,000 55,000,000

Year 1 2 3 4 5 6

Net cash flows to subsidiary S$5,000,000 12,000,000 50,000,000 80,000,000 80,000,000 80,000,000

UKFF3313 Strategic Financial Management (May 2011)

Scenario 5

Year 1 2 3 4 5 6
Scenario 6

Net cash flows to subsidiary S$20,000,000 20,000,000 20,000,000 28,000,000 51,000,000 61,000,000

Year 1 2 3 4 5 6

Net cash flows to subsidiary S$20,000,000 22,000,000 30,000,000 45,000,000 58,000,000 62,000,000

UKFF3313 Strategic Financial Management (May 2011)

Question 3:

What Do You Mean By Country Risk? The purpose of this exercise is to provide you with additional information about capital budgeting and the international sector. After this exercise, you will know where to look when in need of country specific information about the economy, politics, or cultural data. Firms investing in the foreign sector need to consider all of these factors and more in order to make a decision about the level of country specific risk Firms are increasing their investment in international markets and the importance of the global marketplace cannot be understated. In fact, some companies such as Coca-Cola now derive over 80 percent of their beverage profits from the foreign sector. In light of this trend toward globalization firms are looking more and more at direct foreign investment in a number of countries. However, we also know that the risks associated with foreign investment are typically greater than those associated with domestic investment. Let's do some simple country risk assessment. Check out the following Internet location for a run down on specific countries. http://globaledge.msu.edu/resourcedesk/statistical-data-sources/ https://www.cia.gov/library/publications/the-world-factbook/index.html The above web-links provide you with links to information about various countries that should be useful and helpful for making investment decisions. You are required to use the links to identify some countries that you are interested in learning a little more about. In particular, it would be interesting for you to look up a country that you did not even know existed and check out their economy. After you have finished prowling around a little, answer the following questions about country risk. a) What is foreign direct investment and how is it related to capital budgeting? b) What are some of the risks associated with foreign direct investment? 5 marks 5 marks

c) Look up one (1) country of your choice and provide an overview of its economy 10 marks d) What other useful information can you find out about specific countries? 5 marks

e) Based on the country you have chosen in part c) above, review the information about the countrys political conditions. Explain whether these conditions would likely discourage an MNC from engaging in direct foreign investment. Explain how the political conditions could adversely affect the cash flows of the MNC 10 marks Other useful web sites: OECD website www.oecd.org Emerging markets www.emgmkts.com Ranking of countries by political risks www.prsgroup.com IMD World Competitiveness Centre - www.imd.ch/wcc/criteria/index.cfm?display=ge4 Bloombergs economic information on financial markets and countries worldwide www.bloomberg.com

You might also like