Nodal Logistics and Custo Brazil Â Case Solution
Local currency debt financing assuming a BRL 18 million 5-year loan at 15% as an approxiationm
|Less: Interest Expense||15%||2700000||2700000||2700000||2700000||2700000|
|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|
|% 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.
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. Johnâ€™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.
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 Johnâ€™s estimation and this contract would not prove to beneficial in the case of appreciation ofthe BRL.
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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