Solution to Continuing Case Problem: Blades, Inc. 1. One point of concern for you is that there is a tradeoff between the higher interest rates in Thailand and the delayed conversion of baht into dollars. Explain what this means. ANSWER: If the net baht-denominated cash flows are converted into dollars today, Blades is not subject to any future depreciation of the baht that would result in less dollar cash flows. 2. If the net baht received from the Thailand operation are invested in Thailand, how will U.S. operations be affected? (Assume that Blades is currently paying 10 percent on dollars borrowed, and needs more financing for its firm.) ANSWER: If the cash flows generated in Thailand are all used to support U.S. operations, then Blades will have to borrow additional funds in the U.S. (or the international money market) at an interest rate of 10 percent. For example, if the baht will depreciate by 10 percent over the next year, the Thai investment will render a yield of roughly 5 percent, while the company pays 10 percent interest on funds borrowed in the U.S. Since the funds could have been converted into dollars immediately and used in the U.S., the baht should probably be converted into dollars today to forgo the additional (expected) interest expenses that would be incurred from this action. 3. Construct a spreadsheet that compares the cash flows resulting from two plans. Under the first plan, net baht-denominated cash flows (received today) will be invested in Thailand at 15 percent for a one-year period, after which the baht will be converted to dollars. The expected spot rate for the baht in one year is about $0.022 (Ben Holt’s plan). Under the second plan, net baht-denominated cash flows are converted to dollars immediately and invested in the U.S. for one year at 8 percent. For this question, assume that all baht-denominated cash flows are due today. Does Holt’s plan seem superior in terms of dollar cash flows available after one year? Compare the choice of investing the funds versus using the funds to provide needed financing to the firm. ANSWER: (See spreadsheet attached.) If Blades can borrow funds at an interest rate below 8 percent, it should invest the excess funds generated in Thailand at 8 percent and borrow funds at the lower interest rate. If, however, Blades can borrow funds at an interest rate above 8 percent (as is currently the case with an interest rate of 10 percent), Blades should use the excess funds generated in Thailand to support its operations rather than borrowing.
Plan 1–Ben Holt's Plan Calculation of baht-denominated revenue: Price per pair of "Speedos" × Pairs of "Speedos" = Baht-denominated revenue
4,594 180,000 826,920,000
Calculation of baht-denominated cost of goods sold: Cost of goods sold per pair of "Speedos" × Pairs of "Speedos" = Baht-denominated expenses
2,871 72,000 206,712,000
Calculation of dollar receipts due to conversion of baht into dollars: Net baht-denominated cash flows now (826,920,000 – 206,712,000) Interest earned on baht over a one-year period (15%) Baht to be converted in one year
620,208,000 93,031,200 713,239,200
× Expected spot rate of baht in one year = Expected dollar receipts in one year
$ 0.022 $ 15,691,262
Plan 2—Immediate Conversion Calculation of baht-denominated revenue: Price per pair of "Speedos" × Pairs of "Speedos" = Baht-denominated revenue
Calculation of baht-denominated cost of goods sold: Cost of goods sold per pair of "Speedos" × Pairs of "Speedos" = Baht-denominated expenses
Calculation of dollar receipts due to conversion of baht into dollars: Net baht-denominated cash flows to be converted (826,920,000 – 206,712,000) × Spot rate of baht now = Dollar receipts now Interest earned on dollars over a one-year period (8%) = Dollar receipts in one year
4,594 180,000 826,920,000
2,871 72,000 206,712,000
620,208,000 $ 0.024 $ 14,884,992 1,190,799 $ 16,075,791
Calculation of dollar difference between the two plans: Plan 1 Plan 2 Dollar difference
$ 15,691,262 16,075,791 $ (384,529)
Thus, the cash flow generated in one year by Plan 1 exceed those generated by Plan 2 by approximately $384,529. Therefore, Ben Holt's plan should not be implemented.
