BLADES, INC. CASE

Assessment of Exchange Rate Exposure Blades, Inc., is currently exportin" rel="nofollow">ing roller blades to Thailand and importin" rel="nofollow">ing certain" rel="nofollow">in components needed to manufacture roller blades from that country. Under a fixed contractual agreement, Blades’ primary customer in" rel="nofollow">in Thailand has committed itself to purchase 180,000 pairs of roller blades annually at a fixed price of 4,594 Thai baht (THB) per pair. Blades is importin" rel="nofollow">ing rubber and plastic components from various suppliers in" rel="nofollow">in Thailand at a cost of approximately THB2,871 per pair, although the exact price (in" rel="nofollow">in baht) depends on current market prices. Blades imports materials sufficient to manufacture 72,000 pairs of roller bla- des from Thailand each year. The decision to import materials from Thailand was reached because rubber and plastic components needed to manufacture Blades’ products are in" rel="nofollow">inexpensive, yet of high quality, in" rel="nofollow">in Thailand. Blades has also conducted busin" rel="nofollow">iness with a Japanese supplier in" rel="nofollow">in the past. Although Blades’ analysis in" rel="nofollow">indicates that the Japanese components are of a lower quality than the Thai components, Blades has occasionally imported components from Japan when the prices were low enough. Currently, Ben Holt, Blades’ chief fin" rel="nofollow">inancial officer (CFO), is considerin" rel="nofollow">ing importin" rel="nofollow">ing com- ponents from Japan more frequently. Specifically, he would like to reduce Blades’ baht exposure by takin" rel="nofollow">ing advantage of the recently high correlation between the baht and the yen. Sin" rel="nofollow">ince Blades has net in" rel="nofollow">inflows denomi- nated in" rel="nofollow">in baht and would have outflows denomin" rel="nofollow">inated in" rel="nofollow">in yen, its net transaction exposure would be reduced if these two currencies were highly correlated. If Blades decides to import components from Japan, it would probably import materials sufficient to manufacture 1,700 pairs of roller blades annually at a price of ¥7,440 per pair. Holt is also contemplatin" rel="nofollow">ing further expansion in" rel="nofollow">into foreign countries. Although he would eventually like to establish a subsidiary or acquire an existin" rel="nofollow">ing busin" rel="nofollow">iness overseas, his immediate focus is on in" rel="nofollow">increasin" rel="nofollow">ing Blades’ foreign sales. Holt’s primary reason for this plan is that the profit margin" rel="nofollow">in from Blades’ imports and exports exceeds 25 percent, while the profit margin" rel="nofollow">in from Blades’ domestic production is below 15 percent. Con- sequently, he believes that further foreign expansion will be beneficial to the company’s future. Though Blades’ current exportin" rel="nofollow">ing and importin" rel="nofollow">ing practices have been profitable, Holt is contemplatin" rel="nofollow">ing extendin" rel="nofollow">ing Blades’ trade relationships to countries in" rel="nofollow">in different regions of the world. One reason for this deci- sion is that various Thai roller blade manufacturers have recently established subsidiaries in" rel="nofollow">in the United States. Furthermore, various Thai roller blade manufac- turers have recently targeted the U.S. market by adver- tisin" rel="nofollow">ing their products over the Internet. As a result of this in" rel="nofollow">increased competition from Thailand, Blades is uncertain" rel="nofollow">in whether its primary customer in" rel="nofollow">in Thailand will renew the current commitment to purchase a fixed number of roller blades annually. The current agreement will termin" rel="nofollow">inate in" rel="nofollow">in 2 years. Another reason for engagin" rel="nofollow">ing in" rel="nofollow">in transactions with other, non-Asian, countries is that the Thai baht has depreciated substan- tially recently, which has somewhat reduced Blades’ profit margin" rel="nofollow">ins. The sale of roller blades to other coun- tries with more stable currencies may in" rel="nofollow">increase Blades’ profit margin" rel="nofollow">ins. While Blades will contin" rel="nofollow">inue exportin" rel="nofollow">ing to Thailand under the current agreement for the next 2 years, it may also export roller blades to Jogs, Ltd., a British retailer. Prelimin" rel="nofollow">inary negotiations in" rel="nofollow">indicate that Jogs would be willin" rel="nofollow">ing to commit itself to purchase 200,000 pairs of Speedos, Blades’ primary product, for a fixed price of £80 per pair. Holt is aware that further expansion would in" rel="nofollow">increase Blades’ exposure to exchange rate fluctuations, but he believes that Blades can supplement its profit margin" rel="nofollow">ins by expandin" rel="nofollow">ing. He is vaguely familiar with the different types of exchange rate exposure but has asked you, a fin" rel="nofollow">inancial analyst at Blades, Inc., to help him assess how the contemplated changes would affect Blades’ fin" rel="nofollow">inancial position. Among other concerns, Holt is aware that recent economic problems in" rel="nofollow">in Thailand have had an effect on Thailand and other Asian countries. Whereas the correlation between Asian currencies such as the Japanese yen and the Thai baht is generally not very high and very unstable, these recent problems have in" rel="nofollow">increased the correlation among most Asian currencies. Conversely, the correlation between the British pound and the Asian currencies is quite low. To aid you in" rel="nofollow">in your analysis, Holt has provided you with the followin" rel="nofollow">ing data: EXPECTED EXCHANGE CURRENCY RATE RANGE OF POSSIBLE EXCHANGE RATES British pound $1.50 $1.47 to $1.53 Japanese yen $ .0083 $.0079 to $.0087 Thai baht $ .024 $.020 to $.028 Holt has asked you to answer the followin" rel="nofollow">ing questions: 1. What type(s) of exposure (i.e., transaction, economic, or translation exposure) is Blades subject to? Why? 2. Usin" rel="nofollow">ing a spreadsheet, conduct a consolidated net cash flow assessment of Blades, Inc., and estimate the range of net in" rel="nofollow">inflows and outflows for Blades for the comin" rel="nofollow">ing year. Assume that Blades enters in" rel="nofollow">into the agreement with Jogs, Ltd. 3. If Blades does not enter in" rel="nofollow">into the agreement with the British firm and contin" rel="nofollow">inues to export to Thailand and import from Thailand and Japan, do you thin" rel="nofollow">ink the in" rel="nofollow">increased correlations between the Japanese yen and the Thai baht will in" rel="nofollow">increase or reduce Blades’ transaction exposure? 4. Do you thin" rel="nofollow">ink Blades should import components from Japan to reduce its net transaction exposure in" rel="nofollow">in the long run? Why or why not? 5. Assumin" rel="nofollow">ing Blades enters in" rel="nofollow">into the agreement with Jogs, Ltd., how will its overall transaction exposure be affected? 6. Given that Thai roller blade manufacturers located in" rel="nofollow">in Thailand have begun targetin" rel="nofollow">ing the U.S. roller blade market, how do you thin" rel="nofollow">ink Blades’ U.S. sales were affected by the depreciation of the Thai baht? How do you thin" rel="nofollow">ink its exports to Thailand and its imports from Thailand and Japan were affected by the depreciation?