Problem 12.1 Mauna Loa Macadamia

Mauna Loa, a macadamia nut subsidiary of Hershey's with planations on the slopes of its namesake volcano in Hilo, Hawaii, exports Macadamia nuts worldwide. The Japanese market is its biggest export market, with average annual sales invoiced in yen to Japanese customers of 1,200,000,000. At the present exchange rate of 125/$ this is equivalent to $9,600,000. Sales are relatively equally distributed during the year. They show up as a 250,00,000 account receivable on Mauna Loas balance sheet. Credit terms to each customer allow for 60 days before payment is due. Monthly cash collections are typically 100,000,000. Mauna Loa would like to hedge its yen receipts, but it has too many customers and transactions to make it practical to sell each receivable forward. It does not want to use options because they are considered to be too expensive for this particular purpose. Therefore, they have decided to use a matching hedge by borrowing yen. a. How much should Mauna Loa borrow in yen? b. What should be the terms of payment on the yen loan?

a. How much should Mauna Loa borrow in yen?

Mauna Loa receives cash collections of one hundred million yen per month. This is the source of repayment of any

balance sheet hedge. If Mauna Loa wants to be covered for one year at a time, it would need to borrow one year's

cash flow plus interest, and convert the borrowed yen to US dollar at once. A sample calculation would be:

Sample Values

Units

One month's cash flow

100,000,000

Yen

Months per year

12

One year's cash flow

1,200,000,000

Yen

Plus interest

4%

per annum

Principal and interest

1,248,000,000

Yen

Spot exchange rate

125.00

Yen/US$

US dollars

$9,984,000

US$

Calculate how many yens Mauna Loa should borrow.

1.2 Billion Yen with a annual renewal that covers the foreign exchange and interest rate risk for a whole year. Banks likely will agree to a loan in this amount

b. What should be the terms of payment on the loan?