Assignment task:
Jasmine is a large company which manufactures children's toys. It is a private UK limited company with a diversified shareholder base. The company has its headquarters in London, and as part of a group structure, wholly owns subsidiary companies in the UK, China and the US.
A new chief executive (CEO), Mr. Harold Jordan, was recently appointed by the Board to replace the retiring CEO, Mr. James Hannah, who led the company for the past twenty-five years. During this time, Jasmine has produced an extensive range of products within the children's toy industry. Many of the toys manufactured are protected through patents and trademarks held by the company and the manufacturing business has a small innovation team which is tasked with improving or developing products for markets. Over the last few years, however, the company's profitability has declined through a combination of factors including increasing competition and rising costs. Mr. Jordan has been tasked with reinvigorating the company, and providing growth in the business lines, ultimately impacting on profitability and the overall value of the company.
After undertaking a full review of the company's operations, Mr. Jordan has announced a five-year strategic plan which he calls 'Vision 2028'. Mr. Jordan has suggested that the company needs to restructure, reduce staffing, and crucially, focus on entering new markets in Europe. As part of Vision 2028, Mr. Jordan plans to introduce new environmentally friendly technology to manufacture drones and robots for the toy market; to develop a series of family orientated toys to encourage family bonding; and produce a new range of educational toys. He also has plans to improve the profitability of radio-controlled boats which have been a relatively new venture for the business. He has yet to discuss these plans with the Board, and although he knows he has been hired to provide a new direction for the company, he recognises that Vision 2028 will raise several concerns with his senior colleagues. He has asked you for your assistance in assembling a series of financial documents for the Board
a. In the context of 'Vision 2028', the new management is considering building a new factory in South Korea. The Korean subsidiary will require an initial investment of 200,000m South Korean Won (KRW). Jasmine can borrow money to finance this investment in the UK market, in France, or in South Korea. Appendix Q3 offers information about the borrowing costs in different currencies and an estimation of the future value of FX. Advise which is the best way to finance the Korean factory.
This part is best done in Excel, and then copy and paste your finished work into Word.
Build a table comparing the three KRW, GBP, and EUR borrowing costs. (7 columns and 11 rows).
Your columns will range from Year 0 to Year 5 and have a total payments column.
Set up the initial investment (in KRW) and the three interest rates (9%, 15% and 12%) in the first four rows.
In the next two rows, set up the two exchange rates, i.e. £1 = KRW?, and £1 = EUR? Remember that both currencies are appreciating over five years.
Then, calculate the debt in KRW. The interest calculation is simple interest in each year, and the principal sum is paid back in year 5.
Calculate the GBP debt using the KRW/GBP spot rate in the next row. It's the same process as for KRW but with a different interest rate.
Calculate the EUR debt using the EUR/GBP spot rate in the next row. It's the same process as for KRW but with a different interest rate.
You convert the GBP and EUR values into KRW in the last two rows.
You can now compare the total borrowing cost in each currency in KRW.
You now know the cheapest currency to borrow the required funds from the table. Is this the best financing option?
Now explain the foreign currency risks involved in this exercise, e.g., what if the currency depreciated instead of appreciating?
Please show workings for table.
b. The research department of a large financial institution provided inflation expectations for the next five years. According to the forecasts, UK will have 1.75% more inflation than France and 3.5% higher inflation than South Korea. On the basis of this new evidence, would you reconsider your proposal with regard to financing the Korean factory? Explain your answer. In this part, you introduce inflation into your analysis. What effect would this have on exchange rates? Think of PPP, foreign currency predictions (Appendix Q3.1) against inflation predictions, and the effect on exports from and imports into South Korea.
| Initial investment (KRW) |
200,000 |
| Interest rate in UK (5-year loan) |
0.09 |
| Interest rate in South Korea (5-year loan) |
0.15 |
| Interest rate in France (5-year loan) |
0.12 |
| Spot exchange rate: KRW per GBP |
2,000.00 |
| Expected appreciation of GBP in relation to KRW |
4% per annum |
| Forecasted exchange rate: EUR per GBP |
1.18 |
| Expected appreciation of GBP in relation to EUR |
3% per annum |
Please show any workings for tables.