Q1. From the case study, determine whether Blades' financial position would be affected based on the transaction, translation, or economic exposure. Provide one (1) example of the type of exposure that supports your answer. Justify your response.
Blades are exporting roller blades to Thailand and it imports raw materials form the same country. The company is also planning to import raw materials from Japan because their prices are low. The company made the decision to expand its operations to foreign countries because the exports and imports lead to a higher profit margin than domestic sales. As a result, the risk that the company is facing is transaction exposure. Transaction exposure is understood as the possible exchange gain or loss on the foreign currency- denominated transactions (Wever, Trienekens, & Omta, 2012) .
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For, example if Blades decides to enter into an agreement with Japan to purchase raw materials for producing the roller blades. The price per pair is fixed at 7,440. The current exchange rate is $0.0083, which means that Blades will pay $61.752 per pair. Between the times the agreement is signed and the settlement of the contract the exchange rate can fluctuate to $0.0087 and so Blades will be expected to pay Japan $64.728 per pair. This will affect the profitability of Blades because the purchase price has increased. It may also lead to losses. Also, Blades has entered into a two years contractual agreement to sell the roller blades to Thailand at THB 4,594 per pair and the exchange rate is $ 0.024. In case the exchange rate reduces within the two years, Blades will suffer a loss as the payment will be less and so the contract will not be worth as expected.
Blades can protect itself from transaction exposure through hedging. The company can decide to use currency features, currency swaps, or the combination of the two. The company can also protect itself through the purchase of foreign currency. Hedging can be achieved in various forms such as futures contracts, forward contracts, and money market hedges. Blades can also decide to transact in its currency, meaning that it should insist on payments and invoicing in USD (Wever, Trienekens, & Omta, 2012) .
Q2. From the case study, recommend whether Blades should import components from Japan to reduce its transaction exposure in the long run. Provide a rationale to support your response
From the case, Blades should avoid importing raw materials from Japan in order to reduce transaction exposure in the future. Although there is a strong correlation between the baht and the yen, there is instability in Japan which may affect future transactions. Blades has previously conducted business with a Japanese company and the prices of the raw materials were lower than that of Thailand. Blade should therefore not rely on the current situation as the economic condition of Japan is likely to change, thus affecting the exchange rate (Ito & Shimizu, 2016) . There are high chances that importing from Japan would lead to more transaction exposure in the long run because of the unstable currencies.
It is not worth it for Blades to import raw materials from Japan because of the high risk of transaction exposure in the long run and components are of low quality despite being cheap. In the short-run, the profit margins of Blades will increase because of the low prices of the components, but in the long-run, the exchange rates may fluctuate affecting the price of the components. Foreign expansion is beneficial for the company, but it should not be any country. The company should consider selling its roller blades to countries with stable economies and currencies such as Britain. By entering into a contract with Jogs, a British company, Blades will be reducing its risk to transaction exposure and at the same time increase its profit margin in the long-run.
Q3. Create a unique hypothetical weighted average cost of capital (WACC) and rate of return. Recommend whether or not the company should expand, and defend your position
Hypothetical WACC = 10.92
Weighted % issues by Blades = 60% and 40%
Common Stock = 75%
Debt = 25%
WACC = ((E/V) * R e ) + [((D/V) * R d )*(1-T)]
WACC= (0.25 * 0.75) + (0.10[1-040] * 0.25)
= 0.1875 + (0.06 * 0.25)
= 0.1875 + 0.015
WACC = 20.25%
This WACC of 20.25% is higher than the previous 10.92.
The WACC with constant growth capitalization formula for a new estimate
= $250,000 / (0.2025 – 0.05)
= $250,000 / 0.1525
= 1639344
Blades debt is $400,000 and equity is $1,239,344 (1,639,344 - $400,000).
Component Value Weight
Common Stock $1,239,344 75.6%
Debt $400,000 24.4%
Market value of invested capital $1,639,344 100%
The WACC of 20.25% shows that Blades will likely grow in the future. This is not a perfect outcome because the growth can be affected by many factors. The outcome seems more reliable, meaning the Blades should expand. The company’s common stock is more than the debt meaning that the debt would not act as a constraint to growth. The company can pay more dividends to the investors and it can easily make acquisitions, and buy partners.
References
Ito, T. K., & Shimizu, J. (2016). Exchange rate exposure and risk management: The case of Japanese exporting firms. Journal of the Japanese and International Economies, 41, 17-29.
Wever, M. W., Trienekens, J., & Omta, O. (2012). Managing transaction risks in interdependent supply chains: an extended transaction cost economics perspective. Journal on Chain and Network Science, 12(3), 243-260.
