International Finance 535 - Discussion

From the case study, examine three (3) possible benefits realized by a DFI in Thailand. Compare the tradeoffs of investing now versus a year from now. Provide a rationale for your response.

•From the case study, assuming high unemployment in Thailand and taking Blades unique production process into account, predict the reaction that Thai government might have to Blades making a DFI in Thailand. Determine the appropriate discount rate that Thai government should use when assessing the viability of this project. Provide a rationale for your response.

 

 

BLADES, INC. CASE

 

Consideration of Direct Foreign Investment

 

For the last year, Blades, Inc., has been exporting to Thailand in order to supplement its declining U.S. sales. Under the existing arrangement, Blades sells 180,000 pairs of roller blades annually to Entertainment Products, a Thai retailer, for a fixed price denominated in Thai baht. The agreement will last for another 2 years. Furthermore, to diversify internationally and to take advantage of an attractive offer by Jogs, Ltd., a British retailer, Blades has recently begun exporting to the United Kingdom. Under the resulting agreement, Jogs will purchase 200,000 pairs of Speedos, Blades' primary product, annually at a fixed price of £80 per pair.

Blades' suppliers of the needed components for its roller blade production are located primarily in the United States, where Blades incurs the majority of its cost of goods sold. Although prices for inputs needed to manufacture roller blades vary, recent costs have run approximately $70 per pair. Blades also imports components from Thailand because of the relatively low price of rubber and plastic components and because of their high quality. These imports are denominated in Thai baht, and the exact price (in baht) depends on prevailing market prices for these components in Thailand. Currently, inputs sufficient to manufacture a pair of roller blades cost approximately 3,000 Thai baht per pair of roller blades.

Although Thailand had been among the world's fastest growing economies, recent events in Thailand have increased the level of economic uncertainty. Specifically, the Thai baht, which had been pegged to the dollar, is now a freely floating currency and has depreciated substantially in recent months. Furthermore, recent levels of inflation in Thailand have been very high. Hence, future economic conditions in Thailand are highly uncertain.

Ben Holt, Blades' chief financial officer (CFO), is seriously considering DFI in Thailand. He believes that this is a perfect time to either establish a subsidiary or acquire an existing business in Thailand because the uncertain economic conditions and the depreciation of the baht have substantially lowered the initial costs required for DFI. Holt believes the growth potential in Asia will be extremely high once the Thai economy stabilizes.

Although Holt has also considered DFI in the United Kingdom, he would prefer that Blades invest in Thailand as opposed to the United Kingdom. Forecasts indicate that the demand for roller blades in the United Kingdom is similar to that in the United States; since Blades' U.S. sales have recently declined because of the high prices it charges, Holt expects that DFI in the United Kingdom will yield similar results, especially since the components required to manufacture roller blades are more expensive in the United Kingdom than in the United States. Furthermore, both domestic and foreign roller blade manufacturers are relatively well established in the United Kingdom, so the growth potential there is limited. Holt believes the Thai roller blade market offers more growth potential.

Blades can sell its products at a lower price but generate higher profit margins in Thailand than it can in the United States. This is because the Thai customer has committed itself to purchase a fixed number of Blades' products annually only if it can purchase Speedos at a substantial discount from the U.S. price. Nevertheless, since the cost of goods sold incurred in Thailand is substantially below that incurred in the United States, Blades has managed to generate higher profit margins from its Thai exports and imports than in the United States.

As a financial analyst for Blades, Inc., you generally agree with Holt's assessment of the situation. However, you are concerned that Thai consumers have not been affected yet by the unfavorable economic conditions. You believe that they may reduce their spending on leisure products within the next year. Therefore, you think it would be beneficial to wait until next year, when the unfavorable economic conditions in Thailand may subside, to make a decision regarding DFI in Thailand. However, if economic conditions in Thailand improve over the next year, DFI may become more expensive both because target firms will be more expensive and because the baht may appreciate. You are also aware that several of Blades' U.S. competitors are considering expanding into Thailand in the next year.

If Blades acquires an existing business in Thailand or establishes a subsidiary there by the end of next year, it would fulfill its agreement with Entertainment Products for the subsequent year. The Thai retailer has expressed an interest in renewing the contractual agreement with Blades at that time if Blades establishes operations in Thailand. However, Holt believes that Blades could charge a higher price for its products if it establishes its own distribution channels.

 

Field of study: 

Answer

Financing International Trade

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