Jason Cowne Kazuo Shirai Yen-nhi Do Julie Nguyen ChatreeJirakranjanavanit FIN 570 Dr. Greco July 6, 2009 Westwood Plastics Inc. Foreign Currency Risk Hedging Strategies
Outline • Economic Outlook • Company/Case Background • Products • Industry • Define the issue • Transaction Risk • Analyze the case data • Basic Issues • Immediate Issues • Cause/Effect Diagram • Critical Exchange Rate • Exchange Rate Trends • Generate alternatives • Select decision criteria • Analyze & evaluate alternatives • Conclusions
Case Data Analysis -Economic Outlook Source: CIA World Factbook
Company Background • Westwood Plastics • Core competency – Manufacture & sales of proprietary plastic products in Canadian marketplace. • License Agreement with Schalle Industry (Cologne, Germany) • Exclusive manufacturing and distribution rights to Cryolac
Case Background Westwood Plastics Payment Loan Schalle Industrie (AG) Canadian Bank • Payment is a note (9.1%, n = 10) • Financing from two sources: Schalle & bank • Revenue is in CAD • Expenses is in EUR • The right to manufacture & distribute premium product, Cryolac Mfg. Cryolac
Company Background - Cryolac Products • Dough Box • White Cryolac Plastic ABS • Plastic manufacturing processes: • 1. Injection Molding • II. Extrusion Molding • Cryolac is a specialized proprietary plastic
Company Background -Plastic Industry Over 3,400 companies Employing 113,000 workers $33 billion Canadian dollars in Total Revenues 85% of plastics exports are bound for the U.S. Lowest production costs for the plastics sector among G7 countries
Define the Issue • Time frame: March 01, 2006 • Revenues are in CAD • Expenses are in EUR • Currency market is highly volatile • Effects of depreciating CAD currency • Pay more EUR • Understand effects of income & cash flows (Projected fiscal 2007 results)
Define the Issue • Projected EBT is $12 Mill CAD @ EUR=$1.3536 CAD • Loan covenant EBT > $9 Mill CAD • Understand tools to manage currency exposure • Recent trend shows CAD appreciating • If CAD depreciates, projected EBT not met
A large portion of its expenses are paid in EUR • All of the company’s revenues are denominated in CAD • A monthly licensing fee of 250,000 EUR • Raw materials necessary for the manufacturing of Cryolac • Costs of servicing: 1 million EUR note for partial payment of the upfront licensing fee Define the Issue - Transaction Risk
Analyze the Case Projected EBT@ CAD $1.3536/EUR • Projected Expense in CAD $ 49,944,000(will pay in EUR) • Converted to EUR 36,897,163 at the budgeted exchange rate of 1.3536 CAD/EUR • Budgeted EBT (CAD/EUR) • CAD $62,002,000-CAD $49,944,000 = CAD $12,058
Cause/Effect diagram Comparing the decision criteria Currency trends The best alternative hedging strategy for the company Measurement of hedges and exposures Sources of financial restriction facing Westwood
CAD per 1 EUR Exchange Rate Chart (Jan 2005 – Jan 2007) • If CAD continue to appreciate against EUR at present rate, then year end EBT will be C$13,069 thousand.
EBT forecast without hedge(Assume exchange rate move on 3/1/06 and stay at level)
Decision Criteria Use of Put option is speculative!
Conclusions • Westwood Plastics will use the call option as the optimal hedging strategy • Call Options Advantages • Doesn’t tie up a lot of capital • Limits potential losses without limiting potential gains