Recent empirical evidence has suggested a strong increase in demand for low-quality

baseballs. It is reported that this sudden increase in the demand for baseballs stems from

the rise in the popularity of Major League Baseball. Low quality baseballs are typically

used as practice baseballs for little league baseball teams and for use in unorganized play.

Since the target market consists largely of young adolescents, it is believed that this

venture has long-term profitability. As a result, these baseballs are currently marketed to

little-league aged baseball players, globally. Many small producers, scattered globally

currently serve this perfectly competitive market, where each firm is a price taker. A

Haitian-American limited partnership is considering entering this market with a DFI

project in Haiti. Barring political instability, Haiti is seriously considered because of its

endless supply of low-skill labor, its proximity to the U.S. (the major market where 80%

of the demand resides) and the partnership's influence over the public policy through its

lobbying efforts (in Haiti and in the U.S.). The general partner is a Haitian-American

with strong ties to her homeland. The partnership plans to employ all of the firm's inputs

from Haiti and sell the baseballs in the global market, using the U.S. dollar as the

currency habitat of price.

The project requires an initial investment of 100 million Gourdes and is expected to

produce profits of 50 million Gourdes in the first year of operation and 150 million

Gourdes in the second through fifth years of operations. Due to expected political unrest,

the project will be terminated and all relevant capital will be salvaged at 10% of initial

cost after the fifth year of operation. The current spot exchange rate is 38 Gourdes/1U.S.

$. The risk-free interest rate is 2% in the U.S. and 7% in Haiti. The multinational thinks

that the required rate of return on the market portfolio in the U.S. is 10%, and estimates

that the project beta is about 1.5. There is no information on the required rate of return in

Haiti.

4. (5 pts) What is the all-equity cost of capital (you are able to calculate)for this

project?

5. (10 pts) The partnership hires you as a consultant for the project. Your first

deliverable is to calculate the project's net present value to determine if the project

should be undertaken from an economic perspective.(Assume interest rates to remain

constant for maturities one-through five).

During the first year of operation, there is a failed coup attempt against the president of

Haiti. Dissidents attempt to oust the leader and members of his administration; as a result

of the increase in political instability, Haitians react by transferring capital abroad in Off-

Shore accounts.

6. (10 pts) Analyze the effect of this political event on the Haitian Gourde/US$

exchange rate. What is the net effect on the nominal and real exchange rates?

7. (20 pts) Use supply/demand analysis to determine the net effect of the capital flight

on the dollar-price of the firm's baseballs, the number of baseballs produced and

profit level. Be very precise and carefully explain your results for full credit. (The

solution is graphical, not numerical.)

8. (10 pts) If the partnership wants to hedge against the volatility of the Gourde to

reduce or eliminate transaction and economic exposure, it can do so by using

forward contracts. Develop a hedging strategy using the expected future spot rates in

problem 7 to eliminate FX risk. (Assume the expected future spot rates are an

unbiased estimator of forward rates). What are the sizes of the contracts and their

maturities?

9. (10 pts) The firm may want to use the Haitian Gourde as the currency of habitat. If it

does so, it will sell the baseballs in the Haitian Gourde instead. Analyze this proposal

on economic exposure and risk, given the effect on the Gourde in problem 7.

10. (10 pts) Visit the website of the Chicago Mercantile Exchange. You find futures

exchange rates for a host of currencies and other commodities. Is there a Gourde/US

Dollar futures contract? What is the effect of the absence or presence of such a

contract on foreign direct investments in Haiti? Briefly explain.

11. (10 pts) If the firm instead chooses to hedge using the money market, how will this

strategy be implemented? Be as specific as possible.

Answer rating: 100% (QA)

4 The allequity cost of capital for this project can be calculated using the capital asset pricing model CAPM The formula for the allequity cost of capital is Cost of Equity RiskFree Rate Beta Market ... View the full answer