Big S is a large manufacturer of Stereos in New Zealand which is undergoing severe challenges in conducting business in New Zealand due to the increase in competition by the entry of new and foreign competitors in the stereo industry as well as the current economic situation which is prevailing within the country.Apart from competition with new entrants, Big S is experiencing currency exchange rate risk as the currency of New Zealand i.e. (NZD) is depreciating against the currency of Canada i.e. Canadian Dollar (CAD). Hence, the risks that the company might get exposed causing the company to increase its cost of production, which would eventually result in the reduction in the revenue of the company by almost 15 percent and reduction in return on investment of about 6 percent annually.Hence, to cope up with these challenges and eliminate or mitigate the risk which the company is facing; a thorough analysis will be conducted in this study to determine the feasible options which are available to the company in order to remain competitive within the industry and expand through diversification and other strategies within the domain of the Big S.
The two options which are available to the Big S, Stereo manufacturer is to either invest in the same type of manufacturing company similar to Big S but located in other country or to invest in a company that produces headsets in different country entailing high risk and high return. Hence, diversification analysis regarding the return on investment and risk associated with both the options are conducted in detail below:
Diversification Risk of Option A and Option B
Option A consists of Birdies, a manufacturing company of stereos located in different country, enjoying a monopoly position in the stereo industry of the country in which the company is producing the stereos products whereas, the option B consists of the company â€œPlacardâ€ which is also a manufacturing company of a product i.e. headsets in the United Kingdom. The return on investment for the Birdies is 9 percent for the last five year and the return on investment for Placard is 17 percent for the last three years. Moreover, the standard deviation of risk attached with the investment in Birdies is 6 percent, which is relatively lower in comparison with the Placard that consists of the standard deviation of 13 percent.
Although, the risk and return benefit is more by investing in option A but investing in option B provides greater diversification benefit in comparison with the option A.Investment in option A can result in vertical integration i.e. the same product can be produced by the company at lower cost, but investment in Option B will also decrease the cost of production for the Big S as well as add one more item in the product line of the Big S i.e. the production of headsets. Hence, the diversification benefit is greater by investing in option B due to diversification of product, if the company choose to invest in Option B then the risk is greater due to the fact that the country is considering to increase the policy rate which will eventually increase the cost of production for the company and the estimated increase in ROI is also lower as compared to the investment in Option A. Therefore, investing in option A is considered to be a better option for the company to invest as compared to the risk and return characteristics of the investment related with the options.
Viability of Investment in Birdies and Placard
The viability of investments in option A and option B i.e. investment in Birdies and Placard can be affected by various factors which include changes in inflation, interest rates and exchange rates.
Changes in Inflation
The country in which Birdies is located, is experiencing an inflationary environment and to cope up with the inflationary environment,the government of the country has increased the policy rate i.e. interest rate to almost 10 percent which is considered to be quite high whereas the interest rate is quite low in the country where Placard is located i.e. 0.5 percent, which is expected to increase by the government in order to increase the inflation rate by more than 1 percent.Moreover, changes in inflation will affect the prices of both the investment but in the country; the inflation is expected to decrease as the government is taking necessary steps to curb down the inflation whereas, in option B; the country is putting efforts to increase the inflation which will eventually increase the cost of goods and services provided by the company.(Marco Casiraghi, 2019).
The interest rates also play an important part in affecting the investment in different countries. The interest rate are subjected to the monetary policy adopted by the government of a particular country. The interest rate adjustment by the company determines the direction of the inflation rate that a particular company wants to obtain. Hence, the increase in interest increases the costs of production for the company due to increase in cost of debt whereas the decrease in interest rate decreases the cost of production for the company due to decrease in cost of debt. Therefore, interest rate plays a crucial role in determining and analyzing the investment in a particular country. Hence, the interest rates are expected to increase in the country where Placard is located and interest rate are expected to decrease in the country where the Birdies is located, therefore it is more favorable for the country to invest in Birdies whose interest rate are expected to decrease.(Paolo Guasoni, 2019).
Exchange rate also plays an important role in considering to invest in selected countries. While considering investment in a particular country the company should focus on the economic situation of the country where it considers to invest because strong economic condition will provide an indication that the countryâ€™s currency is expected to appreciate as compared to the weak economic situation in a particular country. Hence, investing in countries whose exchange rates are expected to be appreciated is advantageous for the company in order to increase its profitability due to gain from change in currency translation. Therefore, exchange rates are also related to inflation which indicates that the company should invest in the country where Birdies is located, due to the expected decrease in interest rate which is an indication of currency appreciation and will affect the investment positively; whereas, the investment in Placard is subjected to lower interest rate which indicates that the currency of Placardâ€™s country is expected to depreciate due to governments intent to increase inflation.(Guangzhong Li, 2016).
Scenarios for Investing in Birdies and Placard
Two scenarios which are considered for investing in both the companies are developed i.e. optimistic scenario and the pessimistic scenarios. The impact of both the scenarios are analyzed with regards to interest rate, exchange rate and inflation rate prevailing in the country of these particular companies. Hence, the scenarios are discussed in detail below:
In the optimistic scenario, the interest rate, inflation rate and the exchange rate will be in the favor of investment i.e. if the company invests in option A, the favorable condition indicates that the governmentâ€™s steps toward decreasing inflation will be successful, which will decrease the inflation as well as decrease the interest rate of the country. Moreover, the decrease in inflation rate and interest rate is considered the positive sign for the company because of the fact that when the inflation and the interest rate of the country declines it provides an indication that the countryâ€™s exchange rate is going to be appreciated as compared to the countries whose interest rate and inflation rate appears to be increasing. If Big S chooses to invest in Placard which is option B, the optimistic scenario indicates that the interest rate of the company will not be changed by the country and inflation rate will emerge according to the policy need of the country without an increase in policy rate. Hence, these optimistic scenario will eventually enhance the chances of profitability for Big S.
The country in which Birdies is located, is heavily dependent on the world commodities prices and the economic situation prevailing in the country. The price of goods are affected by these macro-economic conditions in Country A in which Birdies is located. In optimistic view, the investment in Birdies will be successful if the oil prices remain low in the international market and the countryâ€™s political situation and labor cost will remain stable. Whereas, the United Kingdom is politically and economically stable, the only effect which will increase the price of the goods is the increase in international oil prices(Paolo Guasoni, 2019…….
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