Five-Period Exchange Rate Analysis - Assignment Example

Corporate Finance Task Introduction The company intends to engage in capital expenditure that would require an initial outlay of AED 55 million. The purchase can be made from two different suppliers situated in two different locations (The UK and Europe). As a result, the concept of exchange rate is considered crucial during the purchase. The reason is exchange rates tend to fluctuate from time to time thereby changing the price of goods and services purchased from an international market. On that note, one of the must-do obligations in this assignment is to study the exchange rate movements for AED against Euros and AED against the pounds. The study will be conducted for five days from 23rd December 2014 to 27th December 2014. The equipment is needed in January 2015. The estimated transportation cost is AED 5 million. The company intends to spend the remaining AED 50 million towards the equipment purchase. The equipment is quoted to cost £ 860,000 and € 1,090,000 in pounds and Euros respectively. The study of the currency movement will aid the purchase at a lower price. Therefore, this assignment presents a five-day exchange rate in a table format showing the value of AED 50 million, for each day, in both the currencies (Pounds and Euros). For each of the five days, the cost of the purchase and the impact of the decision are presented. Last, a report that provides justifications that the decision made is favourable to the company also is provided. Five-period exchange rate In the table below, the exchange rates, which were observed from 23rd to 27th of December, have been presented as Day one to five. The table represents the value of 1AED/POUND and 1AED/EURO. Table 1: the exchange rates DAY 1 2 3 4 5 AED 1 1 1 1 1 GBP 0.175474 0.175106 0.175034 0.175036 0.174997 EURO 0.223548 0.223321 0.22232 0.223595 0.223119 Source: adopted from XE Live Exchange Rates, 2014 The value of AED 50 million The table 2 below represents the value of AED 50 million when converted to both pounds and Euros using the observed exchange rates in table 1 above. Table 2: the value of AED 50 million DAY 1 2 3 4 5 AED 50 m 50 m 50 m 50 m 50 m GBP 8773700 8755300 8751700 8751800 8749850 EURO 11177400 11166050 11116000 11179750 11155950 Source: adopted from XE Live Exchange Rates, 2014 The transactions (Pounds) For the purpose of purchasing the equipment, the currency used for the transaction is the Euros. The table 3 below shows the cost of the equipment in AED based on the exchange rates observations presented in table 1 above. The equipment is quoted to cost € 1,090,000. Therefore, after incorporating the exchange rates, the costs are below. Table 3: the cost of purchasing the equipment (Euros) DAY 1 2 3 4 5 Quoted price 1,090,000 1,090,000 1,090,000 1,090,000 1,090,000 Exchange rate 0.223548 0.223321 0.22232 0.223595 0.223119 New cost 4875910 4880867 4902843 4874885 4885285 Source: adopted from XE Live Exchange Rates, 2014 Table 4: the cost of purchasing the equipment (pounds) DAY 1 2 3 4 5 Quoted price 860,000 860,000 860,000 860,000 860,000 Exchange rate 0.175474 0.175106 0.175034 0.175036 0.174997 New cost 4901011 4911311 4913331 4913275 4914370 Source: adopted from XE Live Exchange Rates, 2014 Day 1 From the table 3 above, the company will spend (1,090,000/0.223548) = AED 4,875,910 to purchase the equipment on the first day. €1,090,000 is the price quoted in Euros. In order to determine the cost of purchasing the equipment on day 1, the quote price is divided by the exchange rate (AED/£) on that day. Recapture that AED 50 million was allocated for the expenditure. Therefore, by making the decision to purchase the equipment, the company will save (50,000,000 – 4,875,910) = AED 45,124,090 for the reason that the equipment will be worth less than the planned cost (XE Live Exchange Rates, 2014). The company’s capital expenditure will be significantly reduced, thereby increasing its financial flexibility (ability to pursue other profitable investments). The decision to purchase the equipment at this point is considered as the best decision for the reason that the equipment was the second cheapest compared to other days. For instance, the firm would save (4880867 – 4,875,910) = AED 4,957 if the equipment was purchased on day one as compared to day 2 (XE Live Exchange Rates, 2014). Day 2 From the table 3 above, the company will spend AED 4,880,867 to purchase the equipment on the first day. Recapture that AED 50 million was allocated for the expenditure. Therefore, by making the decision to purchase the equipment, the company will save (50,000,000 – 4,880,867) = AED 45,119,133 for the reason that the equipment will be worth less than the planned cost (XE Live Exchange Rates, 2014). The company’s capital expenditure will be significantly reduced, thereby increasing its financial flexibility (ability to pursue other profitable investments). The decision to purchase the equipment at this point is considered favourable for the reason that the equipment was cheap compared to its cost in the successive days. For instance, the equipment is worth AED 21,976 less in day 2 as compared to day 3 (XE Live Exchange Rates, 2014). Day 3 From the table 3 above, the company will spend AED 4,902,843 to purchase the equipment on the first day. Recapture that AED 50 million was allocated for the expenditure. Therefore, by making the decision to purchase the equipment, the company will save (50,000,000 – 4,902,843) = AED 45,097,157 for the reason that the equipment will be worth less than the planned cost (XE Live Exchange Rates, 2014). The company’s capital expenditure will be significantly reduced, thereby increasing its financial flexibility (ability to pursue other profitable investments). The decision to purchase the equipment at this point is considered unfavourable for the reason that the equipment was the most expensive as compared to the other four days. For instance, the equipment is worth AED 27,958 more than in day 4 and was worth AED 21,976 more than the cost in day 2 (XE Live Exchange Rates, 2014). Day 4 From the table 3 above, the company will spend AED 4,874,885 to purchase the equipment on the first day. Recapture that AED 50 million was allocated for the expenditure. Therefore, by making the decision to purchase the equipment, the company will save (50,000,000 – 4,874,885) = AED 45,125,115 for the reason that the equipment will be worth less than the planned cost (XE Live Exchange Rates, 2014). The company’s capital expenditure will be significantly reduced, thereby increasing its financial flexibility (ability to pursue other profitable investments). The decision to purchase the equipment at this point is considered the best for the reason that the equipment is the cheapest compared to the cost during the rest of the days. For instance, the equipment is worth AED 27,958 less than the cost in day 3. On the other hand, the equipment’s price is AED 10,400 less than the price on day 5 (XE Live Exchange Rates, 2014). Day 5 From the table 3 above, the company will spend AED 4,885,285 to purchase the equipment on the first day. Recapture that AED 50 million was allocated for the expenditure. Therefore, by making the decision to purchase the equipment, the company will save (50,000,000 – 4,885,285) = AED 45,114,715 for the reason that the equipment will be worth less than the planned cost (XE Live Exchange Rates, 2014). The company’s capital expenditure will be significantly reduced, thereby increasing its financial flexibility (ability to pursue other profitable investments). The decision to purchase the equipment at this point is considered unfavourable for the reason that the equipment’s price is the second most expensive compared to its cost during all the other days. For instance, the equipments costs AED 10,400 more than it would cost in day 4. Therefore, the firm would not maximize the advantage created by the exchange rate fluctuations if the equipment were purchased on this day (XE Live Exchange Rates, 2014). Recommendation The financial manager sought to benefit from the exchange rate movements by purchasing the equipment at a point when the price was the lowest during the five-day period. The currency chosen is the Euros for the reason that it present cheaper prices of the equipment as compared to its prices in pounds. In addition, from the above analyses of the five-day equipment cost, it has been identified that day four presents the best opportunity to spend less on the equipment. The reason is that the equipment costs less than the other five days. Thus, the company would acquire a high quality product at a favourable price. Consequently, the decision would partly create a competitive advantage for the company. The competitive advantage would be created when the company purchases the equipment at a price lower than the competitor’s. Comparatively, the company would incur less cost to increase its level of production than its rivals which, is a source of advantage over the competitors’ who would incur high level of costs to acquire a similar equipment. Reference XE Live Exchange Rates. (2014). Retrieved from http://www.xe.com/?c=AED Read More