978-1337269964 Chapter 21 Solution Manual Part 3

subject Type Homework Help
subject Pages 9
subject Words 4907
subject Authors Jeff Madura

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ANSWER:
a. You should be concerned about your exposure, because you can not assume that the inflation rate
c. The demand for your business would likely be affected if you shift the invoice policy. If the peso
weakens, your clients would have to pay more pesos to obtain the dollars needed for your service.
Mexican interest rates are normally substantially higher than U.S. interest rates.
a. Assuming that interest rate parity exists, do you think hedging with a forward rate would be
beneficial if the spot rate of the Mexican peso was expected to decline slightly over time?
b. Would hedging with a money market hedge be beneficial if the spot rate of the Mexican peso was
expected to decline slightly over time (assume zero transaction costs)? Explain.
c. What are some limitations on using currency futures or options that may make it difficult for you
to perfectly hedge against exchange rate risk over the next year or so.
a. In general, there is a lack of long-term currency futures and options on the Mexican pesos. A
consultant suggests that this is no problem because you can hedge your position a quarter at a
time. In other words, the profits that you remit at any point in the future can be hedged by taking
a currency futures or options position three months or so before that time. Thus, while the
consultant recognizes that the peso could weaken substantially in the long-term, he sees no reason
why you should worry about it as long as you continually create a short-term hedge. Do you
agree?
ANSWER:
a. Based on interest rate parity, the forward rate of the peso should have a large discount. Therefore,
b. Hedging with a money market hedge would involve borrowing pesos and converting the pesos
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International Cash Management 2
beneficial. If you do not hedge, the peso is expected to just depreciate slightly. If you hedge, you
c. Currency futures of options may not be available in the size that fits the profit that you wish to
d. The consultant is wrong. If the peso depreciates substantially over time, the amount of dollars that
Chapter 12
a. Explain how your business is subject to translation exposure.
b. How could you hedge against this translation exposure?
c. Is it worthwhile for your business to hedge the translation exposure?
ANSWER:
Chapter 13
Assume that you wanted to expand your Learning English business to other non-U.S. countries where
some individuals may want to speak English.
a. Explain why you might be able to stabilize the profits of your total business in this manner.
Review the motives for direct foreign investment that are identified in this chapter. Which of
these motives are most important?
b. Why would a city such as Montreal be a less desirable site for your business than a city such as
Mexico City?
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International Cash Management 3
c. Describe the conditions in which your total business would experience weak effects even if the
business was spread across 3 or 4 countries.
d. What factors affect the probability of these conditions occurring? (In other words, explain why
the conditions could occur in one set of countries, but not another set of countries).
e. What data would you review to assess the probability of these conditions occurring?
f. Consider that the prevailing service you offer is teaching individuals in Mexico to speak English,
and your business has already created some supplemental pamphlets and CDs that translate
common Spanish terms into English. How could you expand your business in a manner that may
allow you to benefit from economies of scale (and perhaps even benefit from your existing
business reputation)? When you attempt to benefit from economies of scale, do you forgo
diversification benefits? Explain.
g. How would you come to a decision on whether to pursue business expansion that capitalizes on
economies of scale even if it would forgo diversification benefits? Do you think economies of
scale would be more important or less important than diversification for your business?
h. Is there any way to achieve economies of scale and yet still achieve diversification benefits?
ANSWER:
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International Cash Management 4
Chapter 14
a. Review the different items that are used in the multinational capital budgeting example (Spartan
Inc.). Describe the items that would be included on a spreadsheet if you were to conduct a
multinational capital budgeting analysis of investing dollars to expand your existing language
business in a different location.
b. Assume that you recognize your limitations in predicting the future exchange rate of the invoice
currency for your expanded business. You think that there are several possible exchange rate
scenarios, each with equal probability of occurrence. Explain how you could use this information
to estimate the future NPV and make a decision about whether to accept or reject the project.
c. Now assume that there is also much uncertainty about the demand for your service by
individuals. Explain how you can attempt to incorporate this uncertainty along with the
uncertainty of exchange rate movements so that you can make a decision about whether to accept
or reject the project.
d. Explain how you would derive a required rate of return for your capital budgeting analysis. What
type of information would you use to derive the required rate of return?
ANSWER:
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International Cash Management 5
Chapter 15
You have an opportunity to purchase a private competitor called Fernand in Mexico. You will use only
your funds if you decide to purchase the company.
a. When you attempt to determine the value of this company, how will you derive your required rate
of return? Specifically, should you use the U.S. or Mexico risk-free rate as a base when deriving
your required rate of return? Why?
b. Another Mexican firm called Vascon also considers the purchase of this firm. Explain why
Vascon’s required rate of return may be higher than your required rate of return? Is there any
reason why Vascon’s required rate of return may be lower than your required rate of return?
c. Assume that you and Vascon have the same expectations regarding the Mexican cash flows that
will be generated by Fernand. Fernand’s owner is willing to sell the company for 2 million
Mexican pesos. You and Vascon use a similar process to determine the feasibility of acquiring a
target. You both compare the present value of the target’s cash flows to the purchase price of the
target. Based on your analysis, Fernand would generate a positive net present value for your
firm. Based on Vascon’s analysis, Fernand would generate a negative net present value for
Vascon. How could you determine that the acquisition of Fernand is feasible, while Vascon
determines that the acquisition of Fernand is not feasible?
d. Repeat Question c, except reverse the assumptions. Based on your analysis, Fernand would
generate a negative net present value for your firm. Based on Vascon’s analysis, Fernand would
generate a positive net present value for Vascon. How could you determine that the acquisition of
Fernand is not feasible, while Vascon determines that the acquisition of Fernand is feasible?
ANSWER:
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International Cash Management 6
Chapter 16
a. Review the political risk factors, and identify those that could possibly affect your business.
Explain how your cash flows could be affected?
b. Explain why any threats of terrorism due to friction between two countries could possibly your
business, even if the terrorism has no effect on the relations between the U.S. and Mexico.
c. Assume there is an upcoming election in Mexico that may result in a complete change in
government.
d. Explain why such an election can have significant effects on your cash flows.
ANSWER:
Chapter 17
a. Assume that your business is considering expansion within Mexico. You plan to invest a small
amount of U.S. dollar equity into this project, and finance the remainder with debt. You can
obtain debt financing for the expansion in Mexico , but the interest rates in Mexico are higher
than in the U.S. Yet, if you used mostly U.S. debt financing, you are more exposed to exchange
rate risk. Explain why.
b. If you pursue a new project in Mexico , you want to assess the feasibility of the project if you use
mostly U.S. debt financing, versus mostly Mexican debt financing. Yet, you also want to capture
possible exchange rate effects on your cash flows over time. How can you use capital budgeting
to conduct your comparison?
c. You would prefer to avoid using Mexican debt to finance your expansion in Mexico because the
interest rates are high. A consultant suggests that you seek one or more investors in Mexico who
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International Cash Management 7
would be willing to take an equity position in your business. You would provide them with
periodic dividends and they would be partial owners of your company. The consultant suggests
that this strategy circumvents the high cost of capital in Mexico because it uses equity financing
instead of debt financing. Is the consultant correct?
ANSWER:
Chapter 18
a. Recall from the previous chapter that your business is considering expansion within Mexico.
Recall that you plan to invest a small amount of U.S. dollar equity into this project, and finance
the remainder with debt. You can obtain debt financing for the expansion in Mexico , but the
interest rates in Mexico are higher than in the U.S. Today, you receive credit offers from different
banks. You can either obtain a fixed-rate loan in the U.S. at 8 percent for the life of this project, or
a floating-rate loan (rate changes each year in response to market interest rates) in Mexico at 10
percent. Explain how you could estimate the net present value of the project for each alternative
financing method. Include in your explanation how you would account for the uncertainty of
future interest rate movements of the Mexican debt.
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International Cash Management 8
ANSWER:
a. You can use capital budgeting in which you assess the return on your equity investment. The
financing expenses can be counted as cash outflows. In either case, you pay your labor cost and
Chapter 19
Your business provides CDs on learning English that compliment the teaching that is provided by your
employees based in Mexico. Assume that you decide to capitalize on these CDs by selling them to a large
retail store based in Mexico. The CDs are not as effective without the teaching, but can be useful to
individuals who want to learn the basics of the English language. You do not want to take the risk of
sending a case of CDs to the retail store unless you can be sure of receiving payment. Explain how you
can ensure payment for the CDs.
ANSWER:
Chapter 20
If you decide to implement a major marketing campaign in Mexico , you will incur high expenses in
Mexican pesos. You would need to finance the cost of your marketing. You could either borrow dollars at
a low interest rate and convert them to Mexican pesos to cover the cost, or borrow Mexican pesos to
cover the cost. You would expect to pay off the loan on a monthly basis over the next year with the use of
a portion of the revenue you generate from your business in Mexico.
a. Would your business be more exposed to exchange rate risk if you borrow dollars or Mexican
pesos?
b. Explain how you would make the decision to borrow dollars versus Mexican pesos. What is the
key factor (other than the interest rate of each currency) that will determine whether you should
borrow dollars or Mexican pesos.
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International Cash Management 9
ANSWER:
Chapter 21
Assume that decide not to implement the marketing campaign that you considered in the previous chapter.
You may pursue it next year instead and will attempt to invest some of your profits this year in money
market investments, and then use this money to cover the campaign next year. You can retain your profits
earned this year by investing them in a Mexican bank where interest rates are high. Alternatively, you
could invest the profits in a dollar-denominated bank account. That is, you could convert your Mexican
peso profits to dollars periodically and accumulate the dollars over the year. At the end of the year, you
could convert the dollars back to Mexican pesos, so that you can pay for the marketing campaign. Explain
how you could decide between these two alternatives.
ANSWER:
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