Problem 11.3 Seattle Scientific, Inc.

Assumptions ValuesSeattle's 30-day account receivable, Japanese yen 12,500,000

111.40 111.00 110.40 109.20

Yokasa's WACC 8.850%Seattle Scientific's WACC 9.200%Desired discount on purchase price by Yokasa 4.500%

Josh Miller should compare two basic alternatives, both of which eliminate the currency risk.

1. Allow the discount and receive payment in Japanese yen in cash

Account recievable (yen) 12,500,000 Discount for cash payment up-front (4.500%) (562,500) Amount paid in cash net of discount 11,937,500

Current spot rate 111.40 Amount received in U.S. dollars by Seattle Scientific $ 107,158.89

2. Not offer any discounts for early payment and cover exposure with forwards

Account receivable (yen) 12,500,000 30-day forward rate 111.00 Amount received in cash in dollars, in 30 days $ 112,612.61

Discount factor for 30 days @ Seattle's WACC 0.9924 Present value of dollar cash received $ 111,755.82

Josh Miller should politely decline Yokasa's offer to pay cash in exchange for the requested discount.

Josh Miller is chief financial officer of a medium-sized Seattle-based medical device manufacturer. The companys annual sales of $40 million have been growing rapidly, and working capital financing is a common source of concern. He has recently been approached by one of his major Japanese customers, Yokasa, with a new payment proposal. Yokasa typically orders 12,500,000 in product every other month and pays in Japanese yen. The current payment terms extended by Seattle are 30 days, with no discounts given for early or cash payment. Yokasa has suggested that it would be willing to pay in cash in Japanese yen if it was given a 4.5% discount on the purchase price. Josh Miller gathered the following quotes from his bank on current spot and forward exchange rates, and estimated Yokasas cost of capital.

Spot rate, /$30-day forward rate, /$90-day forward rate, /$180-day forward rate, /$

Problem 11.11 PanAmerican Travel

Assumptions ValuesAcquisition price & 3-month A/P, NewTaiwan dollars (T$) 7,000,000 Spot rate (T$/$) 33.40 3-month forward rate (T$/$) 32.40 3-month Taiwan dollar deposit rate 1.500%3-month dollar borrowing rate 8.000%3-month call option on T$ not availableSusan Takaga's credit line with Bank of Hawaii $ 200,000

Evaluation of Alternatives Cost Certainty 1. Do Nothing -- Wait 3 months and buy T$ spot

If spot rate is the same as current spot rate $ 209,580.84 Risky

If spot rate is the same as 3-month forward rate $ 216,049.38 Risky

Although this would do nothing to cover the currency risk, there would be no required payment or borrowing for 3 -months.

2. Buy T$ forward 3-months

Assured cost of T$ at 3-month forward rate $ 216,049.38 Certain

The purchase of a forward contract would not require any cash up-front, but the Bank of Hawaii would reduce her available credit line by the amount of the forward. This is a non-cash expense.

3. Money Market Hedge: Exchanging US$ for T$ now, depositing for 3-months until payment

Acquisition price in T$ needed in 3-months 7,000,000 Discounted back 3-months at T$ deposit rate 0.9963

Amount of NT$ needed now for deposit 6,973,848 Spot rate, T$/$ 33.40

US$ needed now for exchange $ 208,797.85

US$ carry-forward rate (3-month dollar borrowing rate) 8.000% CertainCarry-forward factor of US$ for 3-month period 1.0200

Total cost in US$ of settling A/P in 3-months with $ 212,973.80 Money Market Hedge

Discussion.

PanAmerican Travel, a Honolulu, Hawaii based 100% privately owned travel company has signed an agreement to acquire a 50% ownership share of Taipei Travel, a Taiwan based privately owned travel agency specializing in servicing inbound customers from the United States and Canada. The acquisition price is 7 million Taiwan dollars (T$ 7,000,000) payable in cash in 3 months.

Susan Takaga, PanAmericans owner, believes the Taiwan dollar will either remain stable or decline a little over the next 3 months. At the present spot rate of T$35/$, the amount of cash required is only $200,000 but even this relatively modest amount will need to be borrowed personally by Susan Takaga. Taiwanese interest-bearing deposits by non-residents are regulated by the government, and are currently set at 1.5% per year. She has a credit line with Bank of Hawaii for $200,000 with a current borrowing interest rate of 8% per year. She does not believe that she can calculate a credible weighted average cost of capital since she has no stock outstanding and her competitors are all also privately-owned without disclosure of their financial results. Since the acquisition would use up all her available credit, she wonders if she should hedge this transaction exposure.

The currency risk is eliminated, but since Susan Takaga would have to exchange the money up-front, it would require her to borrow the money, increasing her debt outstanding for the entire 3 months.

This is a difficult decision. The forward contract appears to be the preferable choice, protecting her against an appreciating T$, and creating a certain cash purchase payment. The problem, however, will be whether the Bank of Hawaii will allow her to purchase a forward for the full $216,049.38, which is slightly above her credit line currently in-place. If her relatonship is good with the bank, they most likely would increase her line sufficiently to allow the forward contract.

Pbm11.3Pbm11.11