You currently own a license to operate a Planet Hollywood restaurant in Cancun, MX. Your leasing/franchising contract
Question:
You currently own a license to operate a Planet Hollywood restaurant in Cancun, MX. Your leasing/franchising contract ends at the end of 2019. This means that the rights of the restaurant will go back to corporate and they will take control of the restaurant.
Nonetheless, since you have been one of their best managers/franchisers, they are willing to renew the contract for 5 more years. The new license will be good for the 2020-2024 period. Planet Hollywood corporate wants MXN$2,300,000 for the license. The forcasted sales for the 2020-2024 Proforma Income Statement are shown below. The current Spot rate is $19.25. While you currently live Mexico, you are thinking of returning to the US and so you are sending all profits back to the US.
Use the sales estimates and Spot estimates to see if you would be willing to pay the MXN$2.3 million to renew the license (i.e., find if the NPV positive) under the following assumptions if your cost of capital (WAAC) is 20%:
a) Assume that the dollar will strengthen 5% in 2020 and 2021 and then by 2% in the 2022-2024 period.
b) Assume that the dollar weakens by 2% per year.
c) If you assume that there is a 50% chance that the dollar will weaken and 50% that it will strengthen as a) and b) state, would you buy a future contract if you can buy it for $19.28 for all years? Explain your reasoning and back up your reasoning with numbers. If you choose to buy the future contract, state how much you would hedge each year.
d) 1-yr interest rates in the US are 2.15% for deposits. In Mexico, 1-yr borrowing interest rates are at 8.2%. Assume that for the next 5 years rates will remain fairly stable in both countries. Would a money market hedge be advisable? You will need to calculate the exchange rates for 2020-2024 using the IFE.
e) What exchange rate would make you indifferent between renewing or not renewing your license?
Expert Answer:
To determine whether renewing the license for MXN23 million is financially viable we need to calculate the Net Present Value NPV of the cash flows gen... View the full answer
