Case Study:

As a financial analyst for Blades, Inc., you are reasonably satisfied with Blades current set-up of exporting Speedos (rollerblades) to Thailand. Due to the unique arrangement with Blades primary customer in Thailand, forecasting the revenue to be generated there is a relatively easy task. Specifically, your customer has agreed to purchase 180,000 pairs of Speedos annually, for a period of three years, at a price of THB4594 (THB = Thai baht) per pair. The current direct quotation of the Australian dollarbaht exchange rate is A$0.0.0381.

The cost of goods sold incurred in Thailand (due to imports of the rubber and plastic components from Thailand) runs at approximately THB2871 per pair of Speedos, but Blades currently only imports materials sufficient to manufacture about 72,000 pairs of Speedos. Blades primary reasons for using a Thai supplier are the high quality of the components and the low cost, which has been facilitated by a continuing depreciation of the Thai baht against the Australian dollar. If the Australian dollar cost of buying components becomes more expensive in Thailand than in the Australia, Blades is contemplating providing its Australian supplier with the additional business.

Your plan is quite simple; Blades is currently using its Thai-denominated revenues to cover the cost of goods sold incurred there. During the last year, excess revenue was converted to Australian dollars at the prevailing exchange rate. Although your cost of goods sold is not fixed contractually as the Thai revenues are, you expect them to remain relatively constant in the near. future. Consequently, the baht-denominated cash inflows are fairly predictable each year because the Thai customer has committed to the purchase of 180,000 pairs of Speedos at a fixed price. The excess Australian dollar revenue resulting from the conversion of baht is used either to support the Australian production of Speedos, if needed, or to invest in Australia. Specifically, the revenues are used to cover cost of goods sold in the Australian manufacturing plant, located in Perth, Western Australia.

Ben Holt, Blades CFO, notices that Thailands interest rates are approximately 15 per cent (versus 8 per cent in Australia). You interpret the high interest rates in Thailand as an indication of the uncertainty resulting from Thailands unstable economy. Holt asks you to assess the feasibility of investing Blades excess funds from operations in Thailand at an interest rate of 15 per cent. After you express your opposition to his plan, Holt asks you to put forward the reasons in a detailed report.

Q4: The difference between the Thai baht interest rate (15per cent) and the Australian dollar interest rate (8 per cent) is 7 per cent. If you anticipate that the Thai baht will depreciate by at least 7 per cent in one year, which (the first or second plan) is it better to exercise? Explain.

Note:

Under the first plan, net baht-denominated cash flows (received today) will be invested in Thailand at 15 per cent for a one-year period, after which the baht will be converted to Australian dollars. The expected spot rate for the baht in one year is about A$0.0361 (Ben Holts plan).

Under the second plan, net baht-denominated cash flows are converted to Australian dollars immediately and invested in Australia for one year at 8 per cent. For this question, assume that all baht-denominated cash flows are due today