Strickler Technology Inc., a Texas-based manufacturer of computer equipment, is considering the establishment of a manufacturing plant in Nepal, a small South Asian country with a population of about 28.1 million. The country’s currency is the Nepalese rupee (NPR), and it is traded against most foreign currencies including the U.S. dollar. The exchange rate between the NPR and the U.S. dollar is quoted in the forex market as:
$1 = NPR 120
The financial team of the company has gathered that Nepal is a parliamentary republic with a multi-party system. Nepal’s GDP was $34.2 billion in 2019 with annual growth rate of 6.6%. Nepal is one of the fastest-growing economies in the world, although the growth rate is expected to decline because of the covid-19 pandemic. Per the agreement with the Nepalese government, the project will be transferred to a local private entrepreneur at the end of 10 years. The financial management team of Strickler Technology Inc. has estimated the cost of the project in Nepal to be US$10 million.
Strickler Technology Inc. is also considering ways to improve its working capital management. The Credit manager of the company, Sean Messer MBA explained that the company can change some aspects of its short-term financial policy from aggressive approach to maturity matching approach to fund current assets to improve its working capital management, which can lead, in turn, to larger free cash flows and greater firm value. A board member, Jacky Jackson was of the view that cash budget is a primary tool of short-term financial planning that can be used to improve the cash management of the company. She believed that having short-to-medium term cash budget for the next five years can help the company identify its short-term financial needs or opportunities and the required amount needed to borrow for the next five years. In that way the company will be able to arrange for short-term finance in advance to reduce the risk of cash shortages.
The Board of the company needs your technical input to decide whether to enter the Nepalese market or not, and best ways to manage its working capital.
1. Based on the exchange rate between the Nepalese rupee and the U.S. dollar, what is the cost of the project in Nepalese rupee?
2. A computer costs $800 in the United States. The same model of computer costs NPR96,800 in Nepal, what is the spot exchange rate between NPR and the US dollar if purchasing power parity holds?
3. Identify three factors that could worsen the exchange rate between the US dollar and the Nepalese rupee.
4. According to the theory of relative purchasing power parity, if inflation in Nepal is predicted to be 9% over the next three years whereas the U.S. inflation rate will be 3%, what will be the exchange rate in three years?
5. Based on the answer to question 4 above, the finance team wants to know whether the Nepali rupee will depreciate or appreciate. (Choose one: depreciate or appreciate) and why?
6. The shareholders of Strickler Technology Inc. want to know the benefits of doing international business in Nepal. List four advantages that can convince the shareholders of the company to accept the project in Nepal.
7. The shareholders also want to know some of the risks associated with doing business in Nepal. Explain three risks the company is likely to face if it goes ahead with the project in Nepal.
8. Using the ratios below:
Inventory conversion period 80 days
Average collection period 55 days
Payables deferral period 52 days
Cash conversion cycle for previous year 79 days
i. Calculate the cash conversion cycle and explain what it means.
ii. Identify three actions that the firm can take to shorten its cash conversion cycle.
9. The cash budget shows that the company will need $2.5 million to finance its working capital needs in next three years. List five sources of financing the company can use to raise the money if it wants to use a self-liquidating approach.
10. List three advantages and disadvantages of using short-term debt rather than long-term debt.