Nodal Logistics and CUSTO Brazil Case Solution
st option to mitigate the risk prevailing in the market is the use of forward rate agreement with the prevailing forward rate in the market.With the help of this contract, the company would be able to lock in the future exchange rates. By analyzing this alternative quantitatively, the forward rate is required which is also given in the case for the years from 2009 to 2013. The present value in this case is$8,966,286.87, which has decreased by 21% from the base case present value which is derived from using the un-hedged alternative available for the company.
With the help of this alternative, the company could be able to gain merits with respect to the higher certainty in the future cash flows,as this hedge can significantly reduce the exchange rate.Moreover,there is no requirement of the upfront cost to be paid for the forward contract whereas, there is always some cost associated with the benefits. With every merits there is also some cost associatedÂ as in this case, the cost comprises of the quoted forward rates on the given case which are weaker than Johnâ€™s estimation and this contract which would,in the case of appreciation in the currency, prove to be disastrous for the company in the future.
One other method available with the company, which can also prove to be most beneficial and the recommended one is to not under taking any hedging alternative and remain un-hedged. It can be seen that the history of appreciation in the currency of Brazil is expected to be followed in the same pattern in the future with respect to the US dollar. By analyzing this alternative quantitatively, it can be concluded that the remaining un-hedged could favor Nodal to cover the exchange rate. However, due to the severe economic conditions prevailing, the chances of exchange risk could prove to be disastrous for the company, which would create issues for the future relating to Mr. Johnâ€™s plan.
With the help of this alternative, the baseline present value is calculated which can be used as a benchmark for the remaining other alternatives available with the company. The present value is calculated to be $11,307,659.64, which is derived by using the discount rate of 10% and taking the fixed BRL rate over the US $ of 1.7950.
The company can also engage in the put option which can also help the company in mitigating the prevailing risk in the market which can cause significant issues for the company in the long run. It gives the company the right but not the obligation to sell the Brazilian currency, which can be exercised using the Put option strike rate (BRL/ $) and the Put option premium for the five years which is also given in the case. After doing it quantitatively, it can be seen that the present value in this alternative is$7,712,101.96.
It can be seen that the value as derived from this alternative is 32% whichdecreased from the base line present value of the un-hedged alternative. The benefits associated with this alternative are that this will allow the company to hedge against the downward fluctuation in the exchange rate as well asit has the potential to benefit from the BRL appreciation.On the other hand, the costs associated with this alternative are the initial outlay of the upfront capital whereas,the cost of using this alternative is that the outlays would accumulate if the option is exercised earlier on.
LOCAL CURRENCY DEBT FINANCING
The company can also mitigate its risk by using the local currency debt by assuming a BRL 18 million 5 year loan at 15%. The use of local currency (Reais-denominated) to finance the subsidiary in-country acts as a partial hedge of the exchange rate exposure. Rather than explicitly hedging against the Brazilian real profit returns, it reduces the total equity risk and exposure in the Brazilian subsidiary. ……………..
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