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FIN 3100/Adam Schor EDISON CASE STUDY Edison is a new company that plans to introduce an electric car using a novel battery technology available in China. You will need to make decisions about where to build plants to satisfy demand in three countries: Brazil, China and the U.S., which the following currencies: Brazilian Real (BRL), Chinese Yuan (CNY) and US Dollar ($). Your marketing department tells you that it has identified three key markets for the cars. Country Brazil China United States Expected Annual Demand 100,000 cars 150,000 cars 200,000 cars Expected Price BRL 112,000 CNY 210,000 $ 30,000 Vour in-house economist gives you the following analysis of each country Your in-house economist gives you the following analysis of each country Country Brazil China United States Exchange Rate 3.7 BRL: 1 USD 6.9 CNY: 1 USD Expected Annual inflation rate 10% 5% 2% The economist also suggests that political uncertainty in Brazil has led to a decrease in foreign direct investment. The exchange rate has been steady for the last year, but the economist noted a sharp drop in foreign reserves. Brazil's central bank has no stated policy about the exchange rate. China has seen strong economic growth and continued strong foreign investment. Most analysts, including your economist, feel that the government would be comfortable with a 3% to 5% annual decrease in the value of the CNY vs. the USD. The U.S. is also seeing strong economic growth but not at the pace of China. Your economist found no signs to suggest that the currency is mispriced vs. most other world currencies, including the Real and the Yuan. Your Production Department Reports on the following costs of production in each country: While steel and aluminum are typically priced in USD, the local producers in Brazil, which tends to be a low-cost producer of steel and aluminum, are willing to price in Brazilian reals for local factories. There is only one source for your battery, which is a Chinese-based producer that sells in CNY. Please note the currency for each entry. Each entry is the price per car Cost Item Aluminum Steel Battery Labor and Other United States $2,000 $2,000 CNY 70,000 $5,000 Brazil BRL 4,000 BRL 4,500 CNY 70,000 BRL 20,000 China $2,000 $2,000 CNY 70,000 CNY 32,000 . Other information for the production department: It costs $1,000 to ship each car from one country to another country. Shipping rates are quoted in USD globally. Cars entering Brazil from another country face a 20% tariff. Cars entering China from another country face a 25% tariff. Cars entering U.S from another country face a 10% tariff. Your marketing department does not feel that you can pass along the tariff to customers. You . . Cars entering U.S from another country face a 10% tariff. Your marketing department does not feel that you can pass along the tariff to customers. You must leave prices at the levels they provided above There are no tariffs on imported parts in any of these countries. Your production department also provides the following estimates on the cost of building a plant. It will take 3 years to complete the plant and the cost will be 40% in year 1, 20% in year 2 and 40% in year 3. The cost is for a plant that produces 150,000 cars/year. Smaller plants are inefficient to build. Country Brazil China United States Annual Production 150,000 cars 150,000 cars 150,000 cars Cost BRL 12.5 billion CNY 19.8 billion $4 billion The finance department reports on your ability to raise capital: You finance department alerts you to the local tax rates: Tax Rates Brazil 25% China 35% United States 30% They also tell you that Edison can hedge using futures up to a three-year term using the forward rates in the market, which will naturally reflect interest rate differentials. Edison can also use put or calls options up to 1 year. The cost for any currency hedge to the USD is 2 cents per $1 hedged for a 3-month option that is at the money. Add 1 cent per option for each additional 3 months until expiration, up to 2 year. Edison can issue equity or bonds in any of these markets or elsewhere in the world. You have decided to raise 75% of the construction costs in debt. Here are the current government interest rates in each country. Edison's borrowing costs will be 3 percentage points higher than the equivalent maturity in the country where it issues the bonds. 1 year 10 years Brazil China U.S. 3 months 6.0% 5.0% 2.0% 6 months 6.5% 5.5% 2.5% 7.0% 6.0% 2.75% 5 years 8.0% 6.0% 3.0% 9.0% 7.0% 3.5% 30 years 10.0% 8.0% 4.5% EDISON PART 2 : Financing Please decide how you will finance the following situations. You do not have to do research into economic conditions or rates. You can make your own assumptions and base your answers on these assumptions. 1. You want to build two plants in Brazil and one plant in China. Check the Edison case study for the costs of the plants. Assume you will have to raise all the money at once. You must raise 30% of the cash needed in equity and 70% in bonds. Consult the case study for the interest rates paid of the debt. Be sure to add the premium over government rates, as noted in the case study. In your answer, explain in which markets you intend to raise the equity and bonds, as well as the currency and the maturity. You can choose several markets, currencies and maturities if you think it is sensible. Remember your goal is to minimize disruption to your business from currency and financial risk. 2. In Brazil, you also want to set up a finance company to help dealers finance their inventories. You have established relationship at a local bank. You expect to lend money to the dealers for three months. The dealers will pay you back from selling their inventory. As new car shipments arrive at the dealerships, you will continue to offer financing to the dealers. You plan to charge the dealers the current short-term interest rate at the time they request financing. The local bank is offering you a choice of either USD loans or Real-denominated loans. They are also offering you either a floating rate loan or a fixed rate loan, as detailed in this table. If you take a floating rate, the rate is set for the term of the loan but will adjust for each loan. If you take a fixed rate option, you must agree to borrow at that rate for three years for each loan you offer the dealers. USD Loans Real Loans Floating Libor + 50 basis points (0.50%) Libor + 150 basis points (1.50%) Fixed 3% 5% Explain which option you will choose and why? Consider the question of currency and fixed vs. floating FIN 3100/Adam Schor EDISON CASE STUDY Edison is a new company that plans to introduce an electric car using a novel battery technology available in China. You will need to make decisions about where to build plants to satisfy demand in three countries: Brazil, China and the U.S., which the following currencies: Brazilian Real (BRL), Chinese Yuan (CNY) and US Dollar ($). Your marketing department tells you that it has identified three key markets for the cars. Country Brazil China United States Expected Annual Demand 100,000 cars 150,000 cars 200,000 cars Expected Price BRL 112,000 CNY 210,000 $ 30,000 Vour in-house economist gives you the following analysis of each country Your in-house economist gives you the following analysis of each country Country Brazil China United States Exchange Rate 3.7 BRL: 1 USD 6.9 CNY: 1 USD Expected Annual inflation rate 10% 5% 2% The economist also suggests that political uncertainty in Brazil has led to a decrease in foreign direct investment. The exchange rate has been steady for the last year, but the economist noted a sharp drop in foreign reserves. Brazil's central bank has no stated policy about the exchange rate. China has seen strong economic growth and continued strong foreign investment. Most analysts, including your economist, feel that the government would be comfortable with a 3% to 5% annual decrease in the value of the CNY vs. the USD. The U.S. is also seeing strong economic growth but not at the pace of China. Your economist found no signs to suggest that the currency is mispriced vs. most other world currencies, including the Real and the Yuan. Your Production Department Reports on the following costs of production in each country: While steel and aluminum are typically priced in USD, the local producers in Brazil, which tends to be a low-cost producer of steel and aluminum, are willing to price in Brazilian reals for local factories. There is only one source for your battery, which is a Chinese-based producer that sells in CNY. Please note the currency for each entry. Each entry is the price per car Cost Item Aluminum Steel Battery Labor and Other United States $2,000 $2,000 CNY 70,000 $5,000 Brazil BRL 4,000 BRL 4,500 CNY 70,000 BRL 20,000 China $2,000 $2,000 CNY 70,000 CNY 32,000 . Other information for the production department: It costs $1,000 to ship each car from one country to another country. Shipping rates are quoted in USD globally. Cars entering Brazil from another country face a 20% tariff. Cars entering China from another country face a 25% tariff. Cars entering U.S from another country face a 10% tariff. Your marketing department does not feel that you can pass along the tariff to customers. You . . Cars entering U.S from another country face a 10% tariff. Your marketing department does not feel that you can pass along the tariff to customers. You must leave prices at the levels they provided above There are no tariffs on imported parts in any of these countries. Your production department also provides the following estimates on the cost of building a plant. It will take 3 years to complete the plant and the cost will be 40% in year 1, 20% in year 2 and 40% in year 3. The cost is for a plant that produces 150,000 cars/year. Smaller plants are inefficient to build. Country Brazil China United States Annual Production 150,000 cars 150,000 cars 150,000 cars Cost BRL 12.5 billion CNY 19.8 billion $4 billion The finance department reports on your ability to raise capital: You finance department alerts you to the local tax rates: Tax Rates Brazil 25% China 35% United States 30% They also tell you that Edison can hedge using futures up to a three-year term using the forward rates in the market, which will naturally reflect interest rate differentials. Edison can also use put or calls options up to 1 year. The cost for any currency hedge to the USD is 2 cents per $1 hedged for a 3-month option that is at the money. Add 1 cent per option for each additional 3 months until expiration, up to 2 year. Edison can issue equity or bonds in any of these markets or elsewhere in the world. You have decided to raise 75% of the construction costs in debt. Here are the current government interest rates in each country. Edison's borrowing costs will be 3 percentage points higher than the equivalent maturity in the country where it issues the bonds. 1 year 10 years Brazil China U.S. 3 months 6.0% 5.0% 2.0% 6 months 6.5% 5.5% 2.5% 7.0% 6.0% 2.75% 5 years 8.0% 6.0% 3.0% 9.0% 7.0% 3.5% 30 years 10.0% 8.0% 4.5% EDISON PART 2 : Financing Please decide how you will finance the following situations. You do not have to do research into economic conditions or rates. You can make your own assumptions and base your answers on these assumptions. 1. You want to build two plants in Brazil and one plant in China. Check the Edison case study for the costs of the plants. Assume you will have to raise all the money at once. You must raise 30% of the cash needed in equity and 70% in bonds. Consult the case study for the interest rates paid of the debt. Be sure to add the premium over government rates, as noted in the case study. In your answer, explain in which markets you intend to raise the equity and bonds, as well as the currency and the maturity. You can choose several markets, currencies and maturities if you think it is sensible. Remember your goal is to minimize disruption to your business from currency and financial risk. 2. In Brazil, you also want to set up a finance company to help dealers finance their inventories. You have established relationship at a local bank. You expect to lend money to the dealers for three months. The dealers will pay you back from selling their inventory. As new car shipments arrive at the dealerships, you will continue to offer financing to the dealers. You plan to charge the dealers the current short-term interest rate at the time they request financing. The local bank is offering you a choice of either USD loans or Real-denominated loans. They are also offering you either a floating rate loan or a fixed rate loan, as detailed in this table. If you take a floating rate, the rate is set for the term of the loan but will adjust for each loan. If you take a fixed rate option, you must agree to borrow at that rate for three years for each loan you offer the dealers. USD Loans Real Loans Floating Libor + 50 basis points (0.50%) Libor + 150 basis points (1.50%) Fixed 3% 5% Explain which option you will choose and why? Consider the question of currency and fixed vs. floating

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