Future Spot Rate Probability, analysis help

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For this week’s course project activities, gather information on Wolverine’s financing requirements and strategies. Based on this information, identify some of the unique challenges that MNCs encounter in their global investment and financing decisions, and options for effectively dealing with these challenges in an era of increasing globalization of business activities.

Complete Parts 4–9 of the analysis:

  1. Assume that Wolverine expects to receive NZ$500,000 at the end of Year 1. The existing spot rate of the New Zealand dollar is $0.60, while the one-year forward rate is $0.62. Wolverine has created a probability distribution for the future spot rate in one year as follows:

Future Spot Rate

Probability

$0.61

20%

$0.63

50%

$0.67

30%

Assume that one-year put options on New Zealand dollars are available with an exercise price of $0.63 and a premium of $0.04 per unit. One-year call options on New Zealand dollars are available with an exercise price of $0.60 per unit. Assume the following money market rates:

United States

New Zealand

Deposit Rate

8%

5%

Borrowing Rate

9%

6%

Given the above information, determine whether a forward hedge, money market hedge, or currency options hedge would be most appropriate to mitigate currency risk. Then, compare your choice of hedging technique to an unhedged strategy and recommend whether Wolverine should hedge its receivables.

  1. Assume that Wolverine expects to need NZ$1 million in one year to meet its short-term obligations (for example, accounts payable). Using any relevant information from Part 4, determine whether a forward hedge, money market hedge, or a currency options hedge would be the most appropriate tool. Then, compare your choice with an unhedged strategy and decide whether Wolverine should hedge its payables positions.
  2. Assume that Wolverine uses the original financing proposal in Part 1 and that funds are blocked until the subsidiary is sold. The funds to be remitted are reinvested at a rate of 6%, after taxes, until the end of Year 3. How is the project NPV affected by this scenario?
  3. What is the break-even salvage value of this project if Wolverine uses the original financing proposal and funds are not blocked? Discuss your answer.
  4. Assume that Wolverine decides to implement the project using the original financing proposal. Also assume that after one year, a New Zealand firm offers Wolverine a price of $27 million after taxes for the subsidiary and Wolverine’s original forecasts for Years 2 and 3 have not changed. Should Wolverine accept or reject the offer? Explain.
  5. Based on the information gathered above, what are some unique challenges that MNCs encounter in their global investment and financing decisions? How should they effectively deal with these challenges in an era of increasing globalization of business activities?

Background info

The fundamental objective of your course project is to conduct a strengths, weaknesses, opportunities, threats (SWOT) analysis of the global business environment. In addition, you will identify specific trends and opportunities as they apply to multinational corporations (MNCs) seeking new opportunities. Results from this endeavor will then be applied to New Zealand as a targeted foreign host location for a hypothetical MNC, the Wolverine Corporation, in conjunction with a country risk analysis. Through this process, you will assess New Zealand’s political and financial risks with the objective of establishing a foreign subsidiary in that country.

Wolverine Corporation Background

This scenario is from your course textbook. After conducting a comprehensive country risk analysis of New Zealand, the Wolverine Corporation, a U.S.-based MNC, has decided to establish a subsidiary in that country as its mode of market entry. The following information has been gathered to assess the feasibility of this project:

  • The initial investment required is $50 million in New Zealand dollars. Given the existing spot rate of US$0.50 per New Zealand dollar, the initial investment in U.S. dollars is $25 million. In addition to the NZ$50 million initial investment for plant and equipment, NZ$20 million is needed for working capital and will be borrowed by the subsidiary from a New Zealand bank. The New Zealand subsidiary will pay interest only on the loan each year at an interest rate of 14 percent. The loan principal is to be paid in 10 years.
  • The project will be terminated at the end of Year 3, when the subsidiary will be sold.
  • The price, demand, and variable cost of the product in New Zealand are as follows:

Year

Price

Demand

Variable Cost

1

NZ$500

40,000 units

NZ$30

2

NZ$511

50,000 units

NZ$35

3

NZ$530

60,000 units

NZ$40

  • The fixed costs, such as overhead expenses, are estimated to be NZ$6 million per year.
  • The exchange rate of the New Zealand dollar is expected to be $0.52 at the end of Year 1, $0.54 at the end of Year 2, and $0.56 at the end of Year 3.
  • The New Zealand government will impose an income tax of 30 percent. In addition, it will impose a withholding tax of 10 percent on earnings remitted by the subsidiary. The U.S. government will allow a tax credit on the remitted earnings and will not impose any additional taxes.
  • All cash flows generated by the subsidiary are to be sent to the parent at the end of each year. The subsidiary will use its working capital to support ongoing operations.
  • The plant and equipment are depreciated over 10 years using the straight-line depreciation method. Since the plant and equipment are initially valued at NZ$50 million, the annual depreciation expense is NZ$5 million.
  • In three years, the subsidiary is to be sold. Wolverine plans to let the acquiring firm assume the existing New Zealand loan. The working capital will not be liquated but will be used by the acquiring firm. When it sells the subsidiary, Wolverine expects to receive NZ$52 million after subtracting capital gains taxes. Assume this amount is not subject to a withholding tax.
  • Wolverine requires a 20 percent rate of return on this project, translated to mean its hurdle rate or weighted average cost of capital.

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