Galaxy Skis has a tough time ahead of itself when it comes to using the international financial market. This is because it is looking at building a plant in China, where the government frequently supports manipulating its currency in order to maintain a competitive edge over other countries in terms of resource and labor cost (Catalan, 2010). This can be problematic for a company that seeks to do continuous business in the country due to the fluctuating market system and exchange rate, though analysts claim that China’s actions will not have long term effects on the flow of trade between the two countries (Slaughter, 2016). However, Galaxy Skis should take efforts to protect itself in case of a changing market by utilizing a few key financial instruments, such as currency futures, currency quotes locked-in on the home currency, and even bulk purchases in order to avoid the small transaction costs of doing business on this market. Galaxy Skis should also not expand to China via means of a factory acquisition, but rely instead on leasing a plant in the country. This would also remove the need of becoming a corporation, though the company’s value would increase and the stock/bonds would be a safe and high-yield investment for portfolio managers.
The most important thing Galaxy Skis can use is buying currency futures. Essentially, a currency future acts as insurance against changing currency conversion rates as the company pays for a specific, locked-in rate long before the actual transaction takes place (CME, n.d.). This might not always benefit the business because the currency might shift in the company’s favor and it could lose money; however, purchasing currency futures helps Galaxy Skis plan ahead and determine the price that will be expected. Therefore, it is critical to note that this device can help Jeremy avoid a deadweight loss if the company reads the financial situation well enough to predict which way the FOREX market will swing. In addition, currency futures will help supply a steadier stream of oil because these futures will allow Jeremy and his company to predict currency costs by knowing the exact amount of money that will be charged for the exchange. Some companies are rightfully willing to pay for the certainty that accompanies these types of financial instruments. Thus, the importance of this instrument is too big to ignore.
Currency futures will definitely help minimize transaction exposure for reasons already listed; however, there are a few more minor things that Galaxy Skis can do in order to minimize transaction exposure. The first is to buy bulk purchases, rather than many small ones over a period of time (Kelly, n.d.). Buying in bulk reduces the accumulated cost of continuously exchanging currency, which happens naturally depending upon the bank that is being used. This method is ideal for larger companies because they can pay for the bill easier than a smaller company could. However, Galaxy Skis has several financial instruments available to finance such a large bulk purchase if they choose to do so, such as receiving loans from financial institutions or becoming a public company.
In addition to these aforementioned methods, Galaxy Skis can also shift the transaction exposure to the company it purchases oil from (Kelly, n.d.). This is as simple as changing the currency that the company is quoting price in. Rather than quote in yuan, for instance, Galaxy Skis can quote all prices in US dollars so that they pay a more constant rate. This does not mean that Galaxy Skis can purchase the oil for a locked in rate, which would definitely benefit the company and would be in Jeremy’s best interests; rather, this helps ensure that it is the other company that bears the costs of transaction exposure as Galaxy Skis would only have to deliver the money in terms of dollars and not have to convert them to yuan first. This method is closer to trickery than anything else, but it would still be a useful tool in Jeremy’s arsenal of risk reduction, provided that the other company accepts this business behavior.
Whether or not Jeremy should purchase the factory or lease it is clear. Assuming it costs fifty million to purchase the factory and use it for fifteen years, with annual expenses of twenty million per year, the total cost of using the factory for that period of time would be three-hundred and fifty million USD. It would only cost one-hundred and fifty million to lease the factory over a fifteen year period, then it would increase Jeremy’s cash flows to lease the plant unless the lifetime of the plant could be extended indefinitely, as Jeremy would have a valuable asset that could be sold in order to generate short-term cash. The need for this is unlikely to rise, as Jeremy should be making a steady profit. In addition, the Chinese inflation rate will only serve to benefit a US based company because their money will be worth substantially more as inflation decreases the value of the Chinese yuan.
However, Jeremy has no reason to become a corporation if Jeremy does not purchase the factory. Galaxy Skis would have no reason to need the amount of capital that could be raised through an initial public offering, and thus, it would be next to useless to the company itself. There are not many benefits to becoming a corporation other than the ease of raising financial capital on the markets, as Jeremy would have to retain control of the company through owning the majority of shares on the market, which can prove stressful if he wants the company to remain his own. Furthermore, as it is not economical for Galaxy Skis to purchase the factory, there is very little reason for Galaxy Skis to become a multi-national corporation which would likely be required to adequately address the costs and difficulties of owning properties on two continents. Regardless of this, it would make sense for Jeremy to automate as much labor as he can, solely due to the fact that it will save labor costs. This is the sole reason that Jeremy has to upgrade his business to a corporation, due to the costs of expanding the factory size in America.
Portfolio managers have a strong reason to invest in Galaxy Skis based upon their strong financial earnings and capital investments. Portfolio managers should use the capital asset pricing model in determining the value of the company overall. The CAPM is designed to demonstrate the viability of the company based on the risk of the security and the time value of the investment (Investopedia.com, 2003). By using the CAPM model and the predictions listed in the case study, investors can predict a rate of return on the stock purchased at about 23.6%, which is higher than their average yearly growth of 15%. Their yearly growth also makes them an attractive investment, as high yearly growth will demonstrate that the company is actively expanding and will likely continue to exhibit a high yield on my investments.
Thus, investors should strongly consider an IPO for Galaxy Skis provided that the company demonstrates it has suitable knowledge of the business climate of China, seeing as that China will become the core of Galaxy Skis’ manufacturing plans. If Galaxy Skis does not have an adequate business strategy for undertaking this big step, investing in the company would be absolutely useless. For an IPO of $15, the offer is extremely attractive however, and my business partners would benefit strongly by having a stable company in their portfolios.
The WACC of Galaxy Skis would not exceed its CAPM rate of return. This is based upon the capital components of the company itself, and it is important because it further illustrates that Galaxy Skis would provide a secure investment for serious and even amateur investors (Investopedia.com, 2003). Because the WACC is so low, it also means that the risk associated with the company remains low and that devaluation is not likely to occur in the business. Thus, this financial tool reveals that Galaxy Skis would currently make a wonderful investment should they decide to take the big risk and become an international corporation, something which Jeremy should carefully consider.
References:
Catalan, J. (2010, April 9). A closer look at china’s currency manipulation. Retrieved September 7, 2016, from Mises, https://mises.org/library/closer-look-chinas-currency-manipulation
CME. Understanding FX Futures. Retrieved September 7, 2016, from CME Group, https://www.cmegroup.com/education/files/understanding-fx-futures.pdf
Investopedia.com (2003). Weighted average cost of capital - WACC. In Investopedia. Retrieved from http://www.investopedia.com/terms/w/wacc.asp
Investopedia.com (2003). Capital asset pricing model - CAPM. In Investopedia. Retrieved from http://www.investopedia.com/terms/c/capm.asp
Kelly, M. Foreign Currency Risk: Minimizing Transaction Exposure. Retrieved September 5, 2016, from International Law, http://www.vsb.org/docs/valawyermagazine/jj01kelley.pdf
Slaughter, M. J. (2016, January 8). The myths of china’s currency “manipulation.” Wall Street Journal. Retrieved from http://www.wsj.com/articles/the-myths-of-chinas-currency-manipulation-1452296887
