Nodal Logistics and Custo Brazil Case Solution & Answer

Nodal Logistics and Custo Brazil  Case Solution

Local currency debt financing assuming a BRL 18 million 5-year loan at 15% as an approxiationm

Project Year   0 1 2 3 4 5 6
Calendar Year RATE 2007 2008 2009 2010 2011 2012 2013
EBIT       4,106,856 6,051,555 6,440,494 6,440,494 6,440,494
Less: Interest Expense 15%     2700000 2700000 2700000 2700000 2700000
EBT       1,406,856 3,351,555 3,740,494 3,740,494 3,740,494
Tax 24%     337645.44 804373.2 897718.56 897718.56 897718.56
Net Income       1,069,211 2,547,182 2,842,775 2,842,775 2,842,775
Add: Depreciation       949,360 949,360 949,360 949,360 949,360
Cash Flows       2,018,571 3,496,542 3,792,135 3,792,135 3,792,135
Fixed Exchange Rate       1.7950 1.7950 1.7950 1.7950 1.7950
Cash flow Proceed       1124551.844 1947934.15 2112610.273 2112610.273 2112610.273
Present Value 10%   $6,974,124.17          
% Difference from the Baseline Present Value (US $)     -38%          

Present a summary of the outcomes (present value) for the various hedging alternatives. Which among the various alternatives would you recommend? Explain your preference and also why not the other alternatives.

In order to come up with the conclusion for Mr. John,each alternative should be viewed thoroughly with respect to their merits and demerits attached with them.

Remain un-hedged

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 looking at this alternative quantitatively, it seems that remaining un-hedged could be in the favor of Nodal to cover the exchange rate however,due to the serious economic conditions prevailing, the chances of exchange risk could prove to be harmful for the company, which would create issues for the future relating to Mr. John’s plan.

By taking the fixed BRL rate over the US $ of 1.7950, the discount rate of 10% and cash flows that are exposed to risk for five years present value, which is also the baseline present value is $11,307,659.64.

Forward contracts

In order to cover the risks that are attached with the opening of RIET in Brazil, Mr. John has the option of taking the forward contract with which the Nodal Logistics would be able to lock in the future exchange rates. In doing the quantitative analysis of this alternative, the forward rate is required which is 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 we have derived from the un-hedged alternative.

The benefit associated with this alternative is 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. In this case, the cost comprises of the quoted forward rates on the given case which are weaker than John’s estimation and this contract would not prove to beneficial in the case of appreciation ofthe BRL.

Put options

The third alternative forMr. John in order to reduce the risk is the Put Option that gives Nodal the right but not the obligation to sell the Brazilian currency. The option can be exercised using the Put option strike rate (BRL/ $) and the Put option premium for the five years which are given in the case. After doing the quantitative analysis, it can be seen that the present value in this alternative is$7,712,101.96.

The value as derived from this alternative is 32% which has decreased from the base line present value of the un-hedged alternative. The benefits associated with this alternative are that this will allow Nodal 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 also if the option is exercised early, then the outlays would accumulate………..

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