International business finance is the trade that focuses mainly on dealing with the financial issues that appears when a company plans to spread its business abroad. The factors are therefore quite necessary to be determined, as they account for the challenges faced by the company under alien economic conditions.
The primary focus of the report is to identify the annual cash flow for the Australian company for BilT, a company that produces body care products and wants to spread its business in Argentina. While doing that, it has to determine the effects of hedging occurring due to the difference in currencies and the variability in the exchange rates. The report also highlights on the issues of determining the best possible financial strategies that needs to be taken by the company in order to generate better revenue. Therefore, it focuses on determining whether to go for the various investments in Australia or in Argentina, based on the financial comparison of the two countries through the method of CAPM.
While assessing the value for the annual cash flow of the company over the assumed period of five years, it is being noted that the value of the net cash is to increase over the various fiscal years in a manner that is roughly linear in nature. This states that the changes in the cash received as well as the cash paid over the period are quite correlative in nature (Akisik, 2013). Moreover, the effect of the external factors is also presumably constant while the cash flow occurs (Barberis et al. 2015).
|
Per Unit |
Units |
Total |
|||||||
|
Sale value per unit |
Units |
Cash received |
Inflation rate |
Variable costs |
$ 50.00 |
200000 |
$ 10,000,000.00 |
||
|
$120.00 |
200000 |
$24,000,000.00 |
10% |
Fixed Cost |
$ 800,000.00 |
||||
|
Cash Paid |
$ 10,800,000.00 |
||||||||
|
Rate of return |
10% |
||||||||
|
Years –> |
0 |
1 |
2 |
3 |
4 |
||||
|
Cash received |
$ 24,000,000.00 |
$ 26,400,000.00 |
$ 29,040,000.00 |
$ 31,944,000.00 |
$ 35,138,400.00 |
||||
|
Cash paid |
$10,800,000.00 |
$11,880,000.00 |
$13,068,000.00 |
$14,374,800.00 |
$15,812,280.00 |
||||
|
Net Cash flow |
$ 13,200,000.00 |
$ 14,520,000.00 |
$ 15,972,000.00 |
$ 17,569,200.00 |
$ 19,326,120.00 |
||||
|
0 |
1 |
2 |
3 |
4 |
|||||
|
Demand |
200000 |
200000 |
200000 |
200000 |
|||||
|
Price per unit |
$ 120.00 |
$ 120.00 |
$ 120.00 |
$ 120.00 |
|||||
|
Total revenue |
$ 24,000,000.00 |
$ 24,000,000.00 |
$ 24,000,000.00 |
$ 24,000,000.00 |
|||||
|
Variable cost per unit |
$ 50.00 |
$ 55.00 |
$ 60.50 |
$ 66.55 |
|||||
|
Total variable cost |
$ 10,000,000.00 |
$ 11,000,000.00 |
$ 12,100,000.00 |
$ 13,310,000.00 |
|||||
|
Annual lease expense |
$ – |
$ – |
$ – |
$ – |
|||||
|
Other fixed annual expenses |
$ 800,000.00 |
880000 |
1064800 |
1417248.8 |
|||||
|
Non cash expenses |
$ – |
$ – |
$ – |
$ – |
|||||
|
Total expenses |
$ 10,800,000.00 |
$ 11,880,000.00 |
$ 13,164,800.00 |
$ 14,727,248.80 |
|||||
|
Before taxearnings subsidiary |
$ 13,200,000.00 |
$ 12,120,000.00 |
$ 10,835,200.00 |
$ 9,272,751.20 |
|||||
|
Host government tax |
$ 4,620,000.00 |
$ 4,242,000.00 |
$ 3,792,320.00 |
$ 3,245,462.92 |
|||||
|
After tax earning subsidiary |
$ 8,580,000.00 |
$ 7,878,000.00 |
$ 7,042,880.00 |
$ 6,027,288.28 |
|||||
|
Net cash flow |
$ 8,580,000.00 |
$ 7,878,000.00 |
$ 7,042,880.00 |
$ 6,027,288.28 |
|||||
|
Amount remitted by subsidiary |
$ 8,580,000.00 |
$ 7,878,000.00 |
$ 7,042,880.00 |
$ 6,027,288.28 |
|||||
|
Withholding tax on remitted funds |
$ – |
$ – |
$ – |
$ – |
|||||
|
Amount remitted after withholding taxes |
$ 8,580,000.00 |
$ 7,878,000.00 |
$ 7,042,880.00 |
$ 6,027,288.28 |
|||||
|
Salvage value |
$ – |
$ – |
$ – |
$ 22,000,000.00 |
|||||
|
Exchange rate |
10% |
10% |
10% |
10% |
|||||
|
Cash flows to parent |
$ 858,000.00 |
$ 787,800.00 |
$ 704,288.00 |
$ 602,728.83 |
|||||
|
PV of parent cash flow |
$ 943,800.00 |
$ 953,238.00 |
$ 937,407.33 |
$ 882,455.28 |
|||||
|
Initial investment by parent |
$ 40,000,000.00 |
||||||||
|
Cumulative NPV |
$ (39,056,200.00) |
$ (38,102,962.00) |
$ (37,165,554.67) |
$ (36,283,099.39) |
Table 1: Annual cash flow for BilT
(Source: Influenced by Learner)
Figure 1: Cumulative cash flow for BilT
(Source: Influenced by Learner)
Hedging is considered a process to reduce the risk associated to the variability in price (Barillas & Shanken, 2015). While a company enters a new market with a different currency structure, there is always a risk associated to the commencement of the business as many of the rates and scales are different, due to a different economic structure (Barth, 2015). As per Berk & Van Binsbergen (2016), hedging is regarded as the only tool to manage and mitigate such risks.
|
0 |
1 |
2 |
3 |
4 |
|
|
Hedge rates |
10.00% |
10.00% |
8.00% |
8.00% |
7.00% |
|
Cash |
$ (40,000,000.00) |
$ 10,000,000.00 |
$ 10,000,000.00 |
$ 10,000,000.00 |
$ 10,000,000.00 |
|
Hedge factor |
1 |
1.1 |
1.1664 |
1.259712 |
1.31079601 |
|
Hedged cash flow |
$ (40,000,000.00) |
$ 9,090,909.09 |
$ 8,573,388.20 |
$ 7,938,322.41 |
$ 7,628,952.12 |
|
Net Present value |
$ (6,768,428.18) |
(Source: Influenced by Learner)
|
0 |
1 |
2 |
3 |
4 |
|
|
Amount remitted after withholding taxes |
$ 8,580,000.00 |
$ 7,878,000.00 |
$ 7,042,880.00 |
$ 6,027,288.28 |
|
|
Hedged cash flows after withholding taxes |
$ 10,000,000.00 |
$ 10,000,000.00 |
$ 10,000,000.00 |
$ 10,000,000.00 |
|
|
Unhedged cash flows |
$ (1,420,000.00) |
$ (2,122,000.00) |
$ (2,957,120.00) |
$ (3,972,711.72) |
|
|
Salvage Value |
$ – |
$ – |
$ – |
$ 22,000,000.00 |
|
|
Forward rate |
10% |
10% |
8% |
8% |
7% |
|
Expected future spot rate |
10% |
10% |
10% |
10% |
10% |
|
Hedged cash flow to parent |
$ 1,000,000.00 |
$ 800,000.00 |
$ 800,000.00 |
$ 700,000.00 |
|
|
Unhedged cash flows to parent |
$ (142,000.00) |
$ (212,200.00) |
$ (295,712.00) |
$ (397,271.17) |
|
|
Total cash flows to parent |
$ 858,000.00 |
$ 587,800.00 |
$ 504,288.00 |
$ 302,728.83 |
|
|
PV of parent cash flow |
$ 780,000.00 |
$ 485,785.12 |
$ 378,879.04 |
$ 206,767.86 |
|
|
Initial investment by parent |
$ 40,000,000.00 |
||||
|
Cumulative NPV |
$ (39,220,000.00) |
$ (38,734,214.88) |
$ (38,355,335.84) |
$ (38,148,567.97) |
(Source: Influenced by Learner)
Figure 2: Cumulative hedged NPV for BilT
(Source: Influenced by Learner)
The Net present value thus determined from the different forward rates of the company across the given period is negative. This shows that the risk has come into effect quite severely and the hedging is not being done properly (Bielecki & Rutkowski, 2013). In case where no revenue is being hedged, the net present value for the investment is being made turns out to be even lower, thus not accounting for any risk management for the initial investment being made. Therefore, it is essential to understand that hedging strategies are obviously the better ones, as they do mitigate some risk by accounting for the net present value of the company while covering up the initial investment.
The process of hedging is being implemented by making a certain payment accounting for the initial investment being done. The amount that was to be hedged was considered $10 million per fiscal year. Without a significant difference in the value of the currencies between Australia and Argentina, the value of the initial investment was bound to be covered up perfectly, thus mitigating the risk and generating a positive net present value.
It is therefore evident that in order to perform the hedging properly, there can be only one possible way that the company must follow. The company needs to understand the fluctuations in the forward rate while conducting the business in Argentina and sending the revenues back to Australia (Bingham & Kiesel, 2013). This assessment done by the company will allow them to reshape the hedge amount according to the forward rate, which will in turn help to generate a positive net present value against the initial investment that has been made (Bodie, 2013).
While assessing the investment strategy for BilT, it is evident that 60% value for the initial investment is to be considered as the initial investment for the company under the revised circumstances. The company has already planned to cover 40% of the initial investment value through their existing funds. Due to the revised initial investment value being recovered through the issuance of debts, there has to be a certain involvement for borrow. The borrow rate for the two different countries, Argentina and Australia are being mentioned to be 6% and 12% respectively. This difference in the rate of borrow has caused the amount paid as interest to be different. The rate of return for the investment has developed the cash flow for the company accordingly, for the period of five fiscal years and the corresponding net present values are determined accordingly, by adding up all the discounted cash flow amounts.
|
Argentina @ 6% |
|||||
|
0 |
1 |
2 |
3 |
4 |
|
|
Investment |
$ (24,000,000.00) |
$ 1,440,000.00 |
$ 2,966,400.00 |
$ 4,584,384.00 |
$ 6,299,447.04 |
|
Rate of Return |
10% |
10% |
10% |
10% |
10% |
|
Discounted cash flow |
$ (24,000,000.00) |
$ 1,584,000.00 |
$ 3,589,344.00 |
$ 6,101,815.10 |
$ 9,223,020.41 |
|
NPV |
$ (3,501,820.48) |
||||
|
Australia @ 12% |
|||||
|
0 |
1 |
2 |
3 |
4 |
|
|
Investment |
$ (24,000,000.00) |
$ 2,880,000.00 |
$ 6,105,600.00 |
$ 9,718,272.00 |
$ 13,764,464.64 |
|
Rate of Return |
10% |
10% |
10% |
10% |
10% |
|
Discounted cash flow |
$ (24,000,000.00) |
$ 3,168,000.00 |
$ 7,387,776.00 |
$ 12,935,020.03 |
$ 20,152,552.68 |
|
NPV |
$ 19,643,348.71 |
Table 4: Calculation of borrow amount
(Source: Influenced by Learner)
While assessing the net present value for both the countries under different rates of borrow, it is evident that the Argentine economy offers a negative value of NPV against the initial investment, whereas the Australian economy offers the chance for a positive NPV against the initial amount that is being debited. The positive value of the NPV therefore concludes the loan to be taken from the Australia, by issuing the debt in any bank of Australia over the likeness of Argentina.
While analyzing the cost of equity for BilT, the method of Capital Asset Pricing Model is being implemented in order to determine the risk associated with making the investment in Australia or in Argentina. The Capital Asset Pricing Model determines the overall value of the payback being affected by the associated risk (Camfferman & Zeff, 2015). This accounts for the assessment of the weighted average of the amount of debt as well as the amount of equity, and finally adding them up (Chegut, Eichholtz & Kok, 2014).
The weighted average is being estimated by multiplying the systematic risk probability to the cost of the debt or the equity (Chui, Fender & Sushko, 2014). This helps in determining the return from a hybrid fund that consists mainly of both the debt as well as equity instruments in a specific proportion (Devlin, 2014).
The cost of equity however, determines the return that the company has decided to generate in order to provide to the shareholders (Dong, Kouvelis & Su, 2014). Moreover, it also accounts for the compensation that the market demands in exchange for owing the assets as well as bearing the systematic risk of owning the company (Du & Schreger, 2016). The capital asset pricing model determines the cost of equity for a firm to be the sum of the risk free rate of return and the product of volatility and risk premium for the particular stock with respect to the market (Fernandez, 2015).
Figure 3: Factors affecting Cost of equity
(Source: Influenced by Chegut, Eichholtz & Kok, 2014, p.179)
Risk free rate is considered the rate of return that is being paid on investments that are free of any systematic risks, such as treasuries and bonds (Fernandez, 2017). Moreover, according to Goss (2013), beta is considered the risk associated to the investment on the stock of the company as compared to the market risk. Therefore, higher value of beta indicates higher volatility of the stock, and therefore, the investment is riskier than the market and has both upside and downside potentials (Henderson et al. 2015). The market premium is considered to be the stand-alone difference between the rate of return for the market and the rate of return that is free of any systematic risk (Jorge & Augusto, 2016).
Figure 4: Estimation of risk free rate
(Source: Influenced by Fernandez, 2017, p.69)
The risk free rate in the context of Australia is 2.77% as of the newest revision done on October 16, 2017 (Jurek, 2014). On the contrary, the risk free rate in the context of Argentina is 2.33% as of the newest revision being done on October 16, 2017 (Lustig, Roussanov & Verdelhan, 2014). The resulting market premium is therefore (10-2.77) % = 7.23% for Australia and (10-2.33) % = 7.67% for Argentina.
As the market premium is being multiplied to the beta value of the stock, which is constant for both the cases, this becomes the determiner for the comparative cost of equity of the company. If the stock of the company has a beta value of one, which is also the representation of cash assets only, the cost of equity for the stock in both the countries becomes exactly equal to ten.
In reality, however, the beta value for a stock can never be one. There has to be some volatility involved with the stock with respect to the market movement (Mazzola & Gerace, 2015). The equations for the corresponding costs of equity for both Australia as well as Argentina respectively, are:
COE = 2.77% + beta*7.23%, and
COE = 2.33% + beta*7.67%
It can therefore be estimated from the above equations that if the stock of the company suffers less volatility as compared to the market, then the cost of equity for the firm in the Australian market will be comparatively higher than the Argentine market, due to the constant term of risk free rate being higher (Moosa, Tawadros & Hallahan, 2015). On the contrary, if the stock for BilT is more volatile than the market, and has a value of beta that is higher than one, the risk premium comes into effect by increasing the weight of the equation, and therefore the Argentine cost of equity turns out is higher than the Australian one. This happens solely due to the contributing factors risk free rate and the risk premium, which determines their contribution to the equations based on the beta value for the stock of the company (Ordelheide, 2016). In other words, if the value for beta is below one, the value for the cost of equity of both the cases drop from 10%, whereas, a beta value of above one results in a rise in the value of the cost of equity above 10%. Issuance of new shares therefore is always an option for the company in the context of the Australian market if the volatility of the stock is lower than one. The reverse is possible when the volatility of the stock is quite higher than one (Wilmott & Orrell, 2017).
The supply and demand are the two main driving factors for the economy of an organization as well as a country. They can solely determine the financial status of the company, of which the concerned product is a part (Wong, Sherris & Stevens, 2017). Therefore, focusing on the two functions are an essential requirement for any of the companies that are planning to establish an economic stronghold.
Figure 5: Effect of global banking crises
(Source: Influenced by Wong, Sherris & Stevens, 2017, p.137)
While in case of a global financial crisis, the value of the exchange rates drops significantly, thus resulting in a sudden devaluation of the currencies (Moosa, Tawadros & Hallahan, 2015). This results in the significant drop in demands for any product, be it human resources or other factors (Wong, Sherris & Stevens, 2017). The result of this economic crisis is a meltdown of the multiple economies, epilepsy of bankruptcy throughout the globe, and unemployment. The drop in demand despite having a surplus of supplies results in severe inflation, thus causing drop in the exchange rates and nuisances for the traders from across the borders (Jurek, 2014).
A crisis in the exchange rate for the currencies can occur mainly due to two reasons. According to Jorge & Augusto (2016), these can be stated as runaway fiscal deficits, and external shocks from other the currencies. While fighting against financial crises, economically challenged countries often tend to print new money in abundance, which often causes the permanent meltdown of the economy (Mazzola & Gerace, 2015). On the other hand, the external shock is mainly caused by the decrease in the demand of the products manufactured by one country in other countries (Wilmott & Orrell, 2017). This results in a price deflation, provided that the exchange rate remains constant for the concerned countries, which in this case are Australia and Argentina. Price deflation results in posing as a difficulty for cutting the prices off, and often ends up in cutting off the salaries of the employees (Chegut, Eichholtz & Kok, 2014). Price deflation also results in causing consistent economic lossage of the firm, and rise in the employment and recruiting process (Camfferman & Zeff, 2015).
Figure 6: Effect of global currency crises (1980-1998)
(Source: Influenced by Camfferman & Zeff, 2015, p.246)
While currency crisis is into effect, the rate of exchange turns out to be more unpredictable (). This occurs due to the importers and the exporters being exposed to higher risk of exchange rates and thereby, choosing to reduce their exposure by reducing tradability (Wilmott & Orrell, 2017). Thus, there is a tremendous negative impact of the currency crisis on the economy of the country and the nature of trade between two countries having different economic structures (Devlin, 2014).
While assessing the situation of the subsidiary of BilT in the Argentine market after three years of being into business and a severe global financial crisis coming into effect during that time, it is to be noted that Argentine economy is quite susceptible to various currency crises over the last thirty years (Camfferman & Zeff, 2015). This creates likelihood for such a situation to arise again, which results the company managers to evaluate the situation beforehand. In order to understand the demand for the sunscreens, the company managers needs to understand primarily that Argentina is a country that is economically quite weaker than Australia. This results the country to be vulnerable to the adverse effects of an economic crisis, as evident from its past records (Wilmott & Orrell, 2017). Therefore, the demand for the product is going to decrease profoundly courtesy to the global crisis and the price deflation, and the exchange rate for the Australian dollar and the Argentine Peso is going to deteriorate more (Chegut, Eichholtz & Kok, 2014). This will be a direct cause of the other traders not ready to trade between the countries due to the deflation and decreased demand of products, which will also account for the significant drop in the exchange rate (Camfferman & Zeff, 2015).
In order to overcome the potential threat associated with the deflation of price, the subsidiary needs to focus more on developing products out of the local pool of resources in spite of using the imported materials from Australia, an economic stronghold of the globe (Devlin, 2014). This will result in the curtailment of the shipping charges, which are to be quite high during the crisis (Chegut, Eichholtz & Kok, 2014). Moreover, the usage of the local resources will also account for the decrease in the costs incurred in production process, due to their availability in abundance and cheap price (). The cheapness of the resources is considered to be a result of the currency of Australia being costlier as compared to the currency of Argentina, thus making the availability of labour and other resources quite cost friendly (Wilmott & Orrell, 2017).
Conclusion
International business parameters are quite complex, as the traders have to deal with multiple economic structures at one time. Therefore, it serves to be one of the biggest challenges for the traders to perform business under varying rates of currencies, and most importantly, under different global financial conditions.
The report has primarily emphasized upon BilT, which is an Australian organization that is into the business of producing body care products. While having produced a new sunscreen, it had aimed to capture the Argentine market, which it thinks to be promising as well as prosperous. Therefore, the report has developed the statement for the annual cash flow of the company in order to determine its impacts in the market for the upcoming five fiscal years. Moreover, the report has also determined the risk associated to the exchange in the currency structure, from conducting the trade in Australia to that in Argentina. The risk is being managed by means of hedging, and therefore, the strategies for various forward rates are being estimated.
The report also determines the net present value for the company; both in the Argentine as well as the Australian context, when it considers the initial investment to be split off against different rates of borrow. Finally, the report discusses the cost of equity based on the CAPM, and the impacts of the currency and other financial crises on the company’s trade.
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