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FINC20023 International Financial Management Assignment Sample

Question and Answer for assignment help

Suppose you are advising an Australian MNE. The company wishes to purchase a device that costs ¥ .
The company is planning to finance this investment in either of the two ways:

Choice 1

Borrow ¥ from a Japanese bank at an interest rate of p.a. for one-year to purchase the device. At the time of repaying the loan, the company will need some Australian dollar cash outlay to convert to the required Japanese yen repayment inclusive of interest.

Choice 2

Borrow A$ from an Australian bank at an interest rate of p.a. for one-year, and then convert the Australian dollar to Japanese yen at the current cross rate of ¥100.00/A$ to purchase the device.

Thus, at the time of repaying this loan also, the company will need some Australian dollar cash outlay.
Assume, the inflation rate in Australia and Japan are, respectively, and 0.95%, and the purchasing power parity (PPP) holds.

i. Which loan option will you advise the company to choose if the choice is solely based on the required Australian dollar cash outlay after 1 year?

ii. What other factors do you think the company will also need to consider concerning this financing decision?

Solution

Answer 1:

The Australian MNE is Planning to buy a device that costs ‘X’ Yens. There are two choices for the Australian MNE. As per the first choice, the company can borrow yen from a Japanese bank at interest. At the time of repayment, the company will need some Australian Dollar cash outlay to convert the Japanese Yen repayment amount along with interest. Hence in this cash outlay, there will be an inflation effect. Hence for conversion also, more Australian dollars will be needed since the conversion will be at the end of year 1.

However, in choice 2, the company shall borrow the dollars from an Australian bank at the current date, and convert the same into yen at the current cross rate and then buy the machine. Here we see that the local inflation shall hold well only since the yen was borrowed at the beginning and hence there is a fixed amount including the interest to be repaid to the Australian bank. The YEN payment is already done at the beginning of the year. Hence, going by the situation, we infer the following with regards to:

Option 1:

The double effect of inflation- since first borrows yen from a Japanese bank, and repay at the end of the year. Due to Japanese inflation, cash outlay will be extra. Also, the company will have to face local inflation and hence, there will be more cash outlay (Marsh 2013).

Option 2:

Single effect of inflation- borrows Australian dollars at interest now, convert into yen and purchase the machine now. There will not be any effect of Japanese inflation. Hence, the cash outlay will be less.
Solely based on the outflow of Australian dollars at the end of year 1, it is advisable to go for option 2 of loan procurement.

Answer 2:

Since there is limited information in the given case, we are trying to judge the situation as per the conditions mentioned in the case.

The given crossover currency rate is yen 100/A$ where A$ stands for Australian Dollar. Since the inflation rate is 0.95% for Yen, it can be assumed that at the end of the year, the rate will be Yen 95/A$. Since there is purchasing power parity, the inflation will be proportional to their exchange rates. However, the interest rate for both Japanese banks as well as the Australian bank has to be considered to ensure which option is best suited. Since purchasing power parity holds well, one certain thing is that the cost of the device, whether purchased in Australia or from Japan, the cost will be similar in net values. Therefore, the cost of the device in either country is not a matter of concern.

What is to be a matter of concern here is the inflation effect on the choice of finance which the company opts for, which has been already discussed in the previous answer. But, the interest rates may vary and that is something we must watch out for since that is a major effect in taking the financing decision (Gunn 2013). Since in choice 2, interest cost is saved, we can consider that to be the most effective cost decision since interest cost will be saved.

References

Gunn, N. (2013). PART 08: Investment planning - chapter 8.4: Risk profiling. London: Kogan Page Ltd. Retrieved from https://search.proquest.com/books/part-08-investment-planning-chapter-8-4-risk/docview/1810512948/se-2?accountid=30552

Marsh, C. (2013). Chapter 01: Stages In The Development Of A Business And Financial Model. London: Kogan Page Ltd. Retrieved from https://search.proquest.com/books/chapter-01-stages-development-business-financial/docview/1810265107/se-2?accountid=30552

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