1. Balance of the account at the end of 45 years:
|
Particulars |
Value |
|
Amount (A) |
$ 10,000.00 |
|
Time (B) |
45.00 |
|
Interest (C) |
13.00% |
|
Balance at retirement |
A*(1+C)^B |
|
Balance at retirement |
10,000*(1+13%)^45 |
|
Balance at retirement |
$ 2,446,414.02 |
|
Particulars |
Value |
|
Balance at retirement (PV) |
$ 2,446,414.02 |
|
Time (n) |
33.00 |
|
Interest (i) |
8.00% |
|
Yearly withdrawal |
PV/((1-((1+i)^-n)))/i) |
|
Yearly withdrawal |
2,446,414.02/((1-((1+8%)^-33)))/8%) |
|
Yearly withdrawal |
$ 212,475.05 |
|
Particulars |
Value |
|
Balance at retirement (A) |
$ 2,446,414.02 |
|
Interest (B) |
8.00% |
|
Withdrawal forever |
A*B |
|
Withdrawal forever |
2,446,414.02 * 8% |
|
Withdrawal forever |
$ 195,713.12 |
1. Calculating current market value of the company’s debt:
|
Particulars |
Value |
|
Face value (F) |
$ 7,500,000.00 |
|
Time (t) |
15.00 |
|
coupon rate |
5.00% |
|
yield year 1 (i) |
5.50% |
|
Coupon payment (C) |
$ 375,000.00 |
|
Price |
(C*((1-(1/((1+i)^t)))/i))+(F/((1+i)^t)) |
|
Price |
(375,000*((1-(1/((1+5.5%)^15)))/5.5%))+(7,500,000/((1+5.5%)^15)) |
|
Price |
7,123,590.71 |
|
Particulars |
Value |
|
Face value (F) |
$ 75,00,000.00 |
|
Time (t) |
14.00 |
|
coupon rate |
5.00% |
|
yield year 2 (i) |
6.50% |
|
Coupon payment (C) |
$ 3,75,000.00 |
|
Price |
(C*((1-(1/((1+i)^t)))/i))+(F/((1+i)^t)) |
|
Price |
(375,000*((1-(1/((1+6.5%)^14)))/6.5%))+(7,500,000/((1+6.5%)^14)) |
|
Price |
6,485,942.74 |
The value of debt for the organisation declined due to the increment in yield.
|
Particulars |
Value |
|
Risk free rate (Rf) |
5.10% |
|
Market return (Rm) |
9.20% |
|
company beta (beta0 |
0.68 |
|
Cost of equity |
Rf + Beta*(Rm-Rf) |
|
Cost of equity |
5.10% + 0.68*(9.20%-5.10%) |
|
Cost of equity |
7.89% |
The beta of 0.698 indicates that the company’s share price is less volatile against price action of the market. Hence, the company with low beta tends to have small risk from investment for the investors.
|
Particulars |
Value |
|
Preference shares value (p) |
$ 1.00 |
|
Current value (c) |
$ 1.63 |
|
Interest (i) |
11% |
|
Cost of preference shares |
(i*p)/c |
|
Cost of preference shares |
(1*11%)/1.63 |
|
Cost of preference shares |
6.75% |
|
Particulars |
Value |
|
Cost of equity (e) |
7.89% |
|
Cost of preference shares (p) |
6.75% |
|
cost of debt (d) |
5.00% |
|
Equity (E) |
$ 65,50,000.00 |
|
Preference (P) |
$ 4,07,500.00 |
|
Debt (D) |
$ 64,85,942.74 |
|
Total capital (T=E+P+D) |
$ 1,34,43,442.74 |
|
Equity weight (WE=E/T) |
48.72% |
|
Preference weight (WP=P/T) |
3.03% |
|
Debt weight (WD=D/T) |
48.25% |
|
WACC |
(WE*e)+(WD*d)+(WP*p) |
|
WACC |
(48.72%*7.89%)+(48.25%*5%)+(3.03*6.75%) |
|
WACC |
6.46% |
|
Particulars |
Value |
|
Cost of equity (e) |
7.89% |
|
Cost of preference shares (p) |
6.75% |
|
cost of debt (d) |
5.00% |
|
Equity (E) |
$ 65,50,000.00 |
|
Preference (P) |
$ 4,07,500.00 |
|
Debt (D) |
$ 64,85,942.74 |
|
Total capital (T=E+P+D) |
$ 1,34,43,442.74 |
|
Equity weight (WE=E/T) |
48.72% |
|
Preference weight (WP=P/T) |
3.03% |
|
Debt weight (WD=D/T) |
48.25% |
|
Tax (T) |
20% |
|
WACC |
(WE*e)+((WD*d)*(1-T))+(WP*p) |
|
WACC |
(48.72%*7.89%)+((48.25%*5%)*(1-20%))+(3.03*6.75%) |
|
WACC |
5.98% |
1. Calculating ARR, Payback period, NPV and IRR of the project:
|
Year |
Cash flow (A) |
Dis-rate (B) |
Dis-cash flow (A*B) |
Cum-cash |
|
0 |
$ -1,25,000.00 |
1.00 |
$ -1,25,000.00 |
$ -1,25,000.00 |
|
1 |
$ 42,000.00 |
0.88 |
$ 36,842.11 |
$ -83,000.00 |
|
2 |
$ 42,000.00 |
0.77 |
$ 32,317.64 |
$ -41,000.00 |
|
3 |
$ 42,000.00 |
0.67 |
$ 28,348.80 |
$ 1,000.00 |
|
4 |
$ 42,000.00 |
0.59 |
$ 24,867.37 |
$ 43,000.00 |
|
5 |
$ 42,000.00 |
0.52 |
$ 21,813.48 |
$ 85,000.00 |
|
Particulars |
Value |
Benchmark |
|
ARR |
13.60% |
12.00% |
|
Payback period |
4.0 |
3.0 |
|
NPV |
$ 19,189.40 |
|
|
IRR |
20.22% |
|
Year |
Cash flow (A) |
Dis-rate (B) |
Dis-cash flow (A*B) |
|
0 |
$ -1,40,000.00 |
1.00 |
$ -1,40,000.00 |
|
1 |
$ 55,000.00 |
0.88 |
$ 48,245.61 |
|
2 |
$ 55,000.00 |
0.77 |
$ 42,320.71 |
|
3 |
$ 55,000.00 |
0.67 |
$ 37,123.43 |
|
4 |
$ 55,000.00 |
0.59 |
$ 32,564.42 |
|
NPV |
$ 20,254.18 |
|
Particulars |
Value |
|
NPV |
$ 19,189.40 |
|
t |
5 |
|
i |
14% |
|
Project 1 EAA |
NPV/((1-((1+i)^-n)))/i) |
|
Project 1 EAA |
19,189/((1-((1+14%)^-5)))/14%) |
|
Project 1 EAA |
$ 5,589.56 |
|
Particulars |
Value |
|
NPV |
$ 20,254.18 |
|
t |
4 |
|
i |
14% |
|
Project 2 EAA |
NPV/((1-((1+i)^-n)))/i) |
|
Project 2 EAA |
20,254.18/((1-((1+14%)^-4)))/14%) |
|
Project 2 EAA |
$ 6,951.33 |
According to the EAA project 2 needs to be accommodated, as it has higher value and can generate more income for the organisation.
1. Calculating the profit margin at spot rate, while finding the critical AUD/USD value and detecting the ideal rate:
|
Particulars |
Value |
|
Sales (A) |
$ 1,00,00,000 |
|
Cost of sales (B) |
AUD 88,00,000 |
|
Spot rate AUD/USD 20th of August (C) |
$ 0.9200 |
|
Cost of sales in USD (D=B*C) |
$ 80,96,000 |
|
Profit (E=A-D) |
$ 19,04,000 |
|
Profit % at current spot rate (F=E/A) |
19.04% |
|
Particulars |
Value |
|
Sales (A) |
$ 1,00,00,000 |
|
Cost of sales (B) |
AUD 88,00,000 |
|
Profit % (C) |
14% |
|
Profit needed (D=A*C) |
$ 14,00,000 |
|
Cost (E) |
$ 86,00,000 |
|
Critical AUD/USD (E/B) |
$ 0.9773 |
|
Particulars |
Value |
|
Sales (A) |
$ 1,00,00,000 |
|
Cost of sales (B) |
AUD 88,00,000 |
|
Profit % (C) |
20% |
|
Profit needed (D=A*C) |
$ 20,00,000 |
|
Cost (E) |
$ 80,00,000 |
|
Ideal AUD/ USD (E/B) |
$ 0.9091 |
The first step is to determine whether payment is to be conducted on different currency, as the home currency of the company. The second step is to detect volatility present within the currency conversion rate. Third step is to detect whether the price action will benefit or harm the currency conversion value. The two examples in which hedging are not needed is that when the government fixes the currency exchange rate. The second example is when the payments in not made in foreign currency, where the risk from volatile currency market does not affect the company (Clark & Judge, 2017).
The future contract is for January, while the actual payment will be conducted on February, which indicates the risk from volatile currency market is high, as adequate hedging will not be conducted for the last month. The future contract with a tenure will 20 February would be beneficial for reducing the risk attributes of the currency market, while the current contract cannot nullify the risk involved in currency conversion (Do & Vu, 2018).
|
100% Hedged with forward contract |
||
|
Particulars |
Value |
Value |
|
Sales (A) |
$ 1,00,00,000 |
$ 1,00,00,000 |
|
Expected forward rate of AUD/USD |
$ 0.9173 |
$ 0.9173 |
|
Expected forward rate of USD/AUD |
1/$ 0.9173 |
1/$ 0.9173 |
|
Expected forward rate of USD/AUD (B) |
AUD 1.09 |
AUD 1.09 |
|
Sale (FC=A*B) |
AUD 1,09,01,351.01 |
AUD 1,09,01,351.01 |
|
Cost of sales (D) |
AUD 88,00,000 |
AUD 88,00,000 |
|
Profit % from hedge (S-D)/S |
19.3% |
19.3% |
|
50% Hedged with forward contract |
||
|
Particulars |
Value |
Value |
|
Sales (A) |
$ 1,00,00,000 |
$ 1,00,00,000 |
|
Spot rate AUD/USD 20th of February |
$1.05 |
$ 0.85 |
|
Spot rate USD/AUD 20th of February |
1/ 1.05 |
1/0.85 |
|
Spot rate USD/AUD 20th of February (B) |
AUD 0.95 |
AUD 1.18 |
|
Expected forward rate of AUD/USD |
$ 0.9173 |
$ 0.9173 |
|
Expected forward rate of USD/AUD |
1/$ 0.9173 |
1/$ 0.9173 |
|
Expected forward rate of USD/AUD (C) |
AUD 1.09 |
AUD 1.09 |
|
Sale (FC=A/2*B) |
AUD 47,61,904.76 |
AUD 58,82,352.94 |
|
Sale (S=A/2*C) |
AUD 54,50,675.51 |
AUD 54,50,675.51 |
|
Sales (T=FC+S) |
AUD 1,02,12,580.27 |
AUD 1,13,33,028.45 |
|
Cost of sales (D) |
AUD 88,00,000 |
AUD 88,00,000 |
|
Profit/Loss from 50% hedge (T-D)/T |
13.83% |
22.35% |
|
100% Hedged with Call option |
||
|
Particulars |
Value |
Value |
|
AUD Call (A) |
$ 0.8800 |
$ 0.8800 |
|
Premium (B) |
$ 0.0200 |
$ 0.0200 |
|
Total call value (C=A+B) |
$ 0.9000 |
$ 0.9000 |
|
Spot rate AUD/USD 20th of February (D) |
$ 1.0500 |
$ 0.8500 |
|
Spot rate AUD/USD 20th of August |
$ 0.9200 |
$ 0.9200 |
|
Profit or loss from hedging (E=D-C) |
$ 0.1500 |
$ 0.0500 |
|
Sales (F) |
$ 1,00,00,000 |
$ 1,00,00,000 |
|
Sales [G=(F*(1/(-E+D)))] |
AUD 1,11,11,111 |
AUD 1,11,11,111 |
|
Cost of sales (H) |
AUD 88,00,000.00 |
AUD 88,00,000.00 |
|
Profit from hedge (I=F-H) |
AUD 23,11,111.11 |
AUD 23,11,111.11 |
|
Profit % from hedge (I/G) |
20.80% |
20.80% |
|
100% Hedged with put option |
||
|
Particulars |
Value |
Value |
|
AUD Put (A) |
$ 0.7500 |
$ 0.7500 |
|
Premium (B) |
$ 0.0005 |
$ 0.0005 |
|
Total call value (C=A+B) |
$ 0.7505 |
$ 0.7505 |
|
Spot rate AUD/USD 20th of February (D) |
$ 1.0500 |
$ 0.8500 |
|
Spot rate AUD/USD 20th of August |
$ 0.9200 |
$ 0.9200 |
|
Profit or loss from hedging (E=D-C) |
$ -0.2995 |
$ -0.0995 |
|
Sales (F) |
$ 1,00,00,000 |
$ 1,00,00,000 |
|
Sales [G=(F*(1/(-E+D)))] |
AUD 74,10,152 |
AUD 1,33,24,450 |
|
Cost of sales (H) |
AUD 88,00,000.00 |
AUD 88,00,000.00 |
|
Profit from hedge (I=F-H) |
AUD -13,89,848.09 |
AUD 45,24,450.37 |
|
Profit % from hedge (I/G) |
-18.76% |
33.96% |
|
100% Hedged with forward contract |
||
|
Particulars |
Value |
Value |
|
Sales (A) |
$ 1,00,00,000 |
$ 1,00,00,000 |
|
Spot rate AUD/USD 20th of February |
$1.05 |
$ 0.85 |
|
Spot rate USD/AUD 20th of February |
1/ 1.05 |
1/0.85 |
|
Spot rate USD/AUD 20th of February (B) |
AUD 0.95 |
AUD 1.18 |
|
Sale (S=A*B) |
AUD 95,23,809.52 |
AUD 1,17,64,705.88 |
|
Cost of sales (D) |
AUD 88,00,000 |
AUD 88,00,000 |
|
Profit % from no hedge (S-D)/S |
7.6% |
25.2% |
The two low cost hedging strategies that can be used by the organisation are the currency swaps and future contracts. The currency swaps can allow the organisation to take adequate loans in USA, while transferring the money to Australia on the spot rate and making the payments after receiving the 10 million dollars to the loan-providing bank. The future contracts can be used for minimising the damage conducted from the currency volatility (Álvarez-Díez, Alfaro-Cid & Fernández-Blanco, 2016).
Reference and Bibliography:
Álvarez-Díez, S., Alfaro-Cid, E., & Fernández-Blanco, M. O. (2016). Hedging foreign exchange rate risk: Multi-currency diversification. European journal of management and business economics, 25(1), 2-7.
Clark, E. A., & Judge, A. P. (2017). The determinants of foreign currency hedging: does foreign currency debt induce a bias?. Evaluating Country Risks for International Investments, 499-536.
Do, V., & Vu, T. (2018). The additional cost of hedging in foreign currency loans. Australian Journal of Management, 43(2), 305-327.
Gotze, U., Northcott, D., & Schuster, P. (2016). Investment appraisal. Springer-verlag berlin an.
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