The real problem is that Blade Inc. has all of its positive cash inflows coming from foreign countries in foreign currencies. The company has economic exposure of £16,000,000 coming from the UK and THB586,920,000 coming from Thailand. The company is also affected by economic and market conditions, especially in Thailand, such as consumer spending on leisure goods, which has declined considerably, high level of inflation, depreciation of the Baht and lastly, the current Thai retailer may not renew the contract with Blade after two years. All of these economic and market conditions can affect sales in Thailand and the $ amount remitted to the Parent U.S. company.
Table of cash flows and currency exposure
In the current operations of the company, Blades, Inc. has a high economic exposure as its cash inflows depend highly on the fluctuations in exchange rates between the $ and the Baht, and the $ and L. The company will be negatively affected by the depreciation of the Baht, which is likely to occur in the future, because of unfavorable economic conditions in Thailand, such as high inflation. Since the materials for only 80,000 pairs of Speedos are purchased in Thailand while 180,000 pairs are exported to Thailand, that means that there are 100,000 pairs that are produced with US materials, and their price will increase in terms of Baht as the Baht depreciates. This will make the 100,000 Speedos more expensive for the company to sell in Thailand.
The company’s margin will have to be reduce because the contract with the Thai retailer is at a fixed of THB4,594 per pair. Because the cash inflows are greater than the cash outflows in Thailand and because Blades, Inc. has a contract for another 2 years, continuing with the current system of operation will cause the company’s revenues to decrease in terms of US dollars if the Baht depreciates. In addition to the economic exposure in Thailand, Blades, Inc. also has high economic exposure in terms of UK Pounds. The company’s greatest part of foreign cash inflows comes from the UK and it has no cash outflows in pounds, so exchange rate fluctuations can affect the company’s cash inflows from the U.K. If the pound depreciates with respect to the dollar, the cash flows of the company will be reduced
Our solution to reduce the economic exposure of the company is the following: Blades, Inc. should borrow pounds in the U.K. in order to reduce its economic exposure in the U.K. and it should use these pounds to finance a new subsidiary in Thailand.
First, by borrowing pounds in the U.K., the company will reduce its economic exposure of pounds since the company will now have cash outflows in the U.K. The company will use the pounds received from the sales of Speedos in the U.K. to pay back the loan, reducing the final inflows of the pounds that will be remitted to the Parent company in the U.S.
Second, by having a subsidiary in Thailand, we will reduce the economic exposure to the fluctuations of Baht and we could take advantage of the depreciation of the Baht. The company should try to produce as much Speedos as possible to sell in Thailand and in the UK and even possibly in the U.S. to increase the outflows of the Baht. If the currency depreciates (Baht), then the company saves money by exchanging $ for the Baht to pay back the production costs incurred in Thailand.
Inflation in Thailand will cause the domestic currency to depreciate against other foreign currencies but if the market is efficient, Purchasing Power Parity should hold, and then the increase in inflation in Thailand will be offset by the appreciation of the $U.S. This means that the inflation in Thailand will not affect the price of exports to the UK and to the U.S.
Third, by opening a subsidiary in Thailand, the company could decrease the variable costs incurred in the U.S. for the import of materials from Thailand and the export cost to Thailand of the goods produced in the U.S.. The subsidiary will decrease the time necessary from the production to the delivery of the Speedos to the retailer in Thailand since the goods will be produced locally.
Fourth, even if the local retailer does not renew its contract with the company, Blades Inc. subsidiary in Thailand would still be able to find another retailer or sell directly to the customers at regular price.
Last, by investing in Thailand, the company will strengthened its positions in Asia and will be ready to enter other Asian markets when economic conditions in the region improve. When this happens it is likely that production costs in Thailand might rise, as the cost of labor might increase, for example. However, the purchasing power of the people in Asia, including Thailand will increase and they will be able to buy more goods, which means that Blades sales in Thailand and possibly other Asian markets will increase. Blade can benefit from acquiring new markets in Asia when economic conditions in Asia improve because the Asian market has a very high growth potential. Also by having a subsidiary in Thailand, the company will diversify its cash flows since the Thai economy and the other Asian economies are not positively correlated with the U.S. and the UK’s economy.
The worst case scenario for the company will be if the Baht exchange rate does not change, consumer spending on leisure goods greatly decreases, and the Thai retailer decides not to renew his contract after the three years are over. Then in this scenario, because the company has its production in Thailand, Blades Inc. will still be able to sell in Thailand even if sales are lower than the preceding contract. It could also export its excess production to the U.K. and maybe even to the U.S. since even without any change in currency, the cost of Speedos produced in Thailand goods is still less expensive than in the U.S.
For the following scenario: if there is no change in the Baht, the cost of THB3,000 @ $.0220 will be approximately $66, which is cheaper than the cost of production in the U.S. If the Baht depreciate by 5 percent, the cost of one pair of Speedo of THB3,000 @ $.0209 will be approximately $62.7. If the Baht depreciate by 10 percent, the cost of THB3,000 @ $.0198 will be approximately $59.4.
If the company does not open a subsidiary in Thailand and keeps importing some of the supplies, then the company will be negatively affected by the depreciation of the Baht. The company will receive less dollars for the goods sold to the importer in Thai since the dollars will have appreciated and because they have a fixed contract for the price of the Speedos of THB4,594. Therefore, the best solution is to open a subsidiary in Thailand, and finance it by borrowing pounds in the U.K. In this way Blades will not only decrease its economic exposure by having cash outflows in UK pounds and in Baht, but it will also make it easier for the company to gain market share in Thailand and in Asia in general when the economic conditions in the region improve.