International Financial Management at Lufthansa - Case Study Example

International Financial Management: Lufthansa Case Study Introduction The purchase of fixed assets for firms is an undertaking that requires deep understanding of the world economic trend. Most fixed assets are purchased on credit and, therefore, the officers responsible for purchasing such items should have sound analytical and decision-making skills. According to Somanath (150), financial management is an essential practice for any organization. In order to understand the practice of international financial management and its challenges, we focus on the Lufthansa Case study. In this case, to determine whether the actions of Herr Ruhnau were reckless, it is essential to consider the various factors that influenced his decisions. Generally, Herr Ruhnau decisions may be viewed as faulty as far as international financial management is concerned. However, some decisions made by Herr Ruhnau were inevitable to mitigate loss and other financial risks associated with the purchase of jets. Analysis of the Lufthansa Case Different firms have varied risk management strategies and policies (Anderson 47). Essentially, firms have risk management policies that classify risks in order to identify the most appropriate course of action to employ when faced with financial uncertainties. Risk management policies should be a guide to the manager when choosing investment options. In Lufthansa’s case, no definite policies were established to handle critical risk. For this reason, Herr Ruhnau did what was good for the firm. Actually, Herr’s decisions were aimed at securing the firm’s profits in the market. Even though the decisions had many flaws, Herr did what was expected of him as a manager. Herr Ruhnau decided to adopt a variety of financial measures to prevent the firm from suffering huge financial losses. For retention of his position at the firm, Herr could argue that, as a chairman of the firm, he had to make the purchasing decision since the changes in value of the foreign currency were unpredictable. In addition, managers are the core decision-makers in any organization Ayse (212). It is impractical for a manager to watch investment opportunities vanish with taking any action. In essence, Herr Ruhnua had to play his role as the chairman to ensure that the daily operations of the firm ran smoothly. Hedging is an effective financial risk management strategy. To some extent, hedging aids in reducing a firm’s expenses. For instance, if a firm chooses to remain uncovered, the premium expense is eliminated. In addition, the money that would have been used for paying insurance premiums can be invested in some profitable ventures. Essentially, remaining uncovered represents the maximum risk approach. In this regard, remaining uncovered bears the potential of producing the most outstanding benefits for the firm. Assuming that the exchange rates dropped at the time of paying for the jets, the cost of purchasing would have significantly reduced. A drop in the exchange rates would have helped Lufthansa save money for use in other projects. Actually, drop in exchange rates can be viewed as internal financing strategy for the firm where remaining uncovered is the risk management strategy employed. Basically, most investors believe that remaining uncovered for a particular period of time is a currency speculation approach to risk management. That is, no one is certain that the projected outcome will eventually happen as anticipated. In this case, the board should retain Herr since his anticipations were that the exchange rates will drop. If the exchange rates dropped with the time of making payments, the firm would have enormously benefited since it would be less amount than the initial budgeted amount. The unfavorable performance of the foreign market should not be blamed on Herr since it was beyond is control. It may be argued that Herr Rhunau made the decision without considering the possibilities of negative outcomes. However, this would be fallacious reasoning since no one in the investment world has perfect knowledge of future happenings. In this regard, it is not justifiable to oust Herr Rhunau from office because his decision resulted in a loss to the firm. Instead, the management should learn from the failures of Herr’s decision and make possible amendments to avoid future repetition of similar errors. Herr was acting for the good of the firm and therefore failure of his approach should not be used to vacate him from office. Failure should be taken positively by firms. It is imperative to identify that the failure of an individual does not mean he/she is incapable, instead the person should be supported to aid in evading such an occurrence in future. Ousting Herr Rhunua is not the solution to the identified problem. Actually several questions need to be asked regarding the removal of Herr from office. For instance, was he acting for personal benefits? If the plans succeed, how would the firm benefit? Is there a perfect person to fill the post? and many others. Valuable officers of a firm should be treated with a lot of respect and care since their contribution means a lot to the firm. Herr Ruhnua preferred to employ forward contact hedging tool instead of options. Critics viewed this as a defective decision since purchase of put options would have salvaged the investment in an event of adverse exchange rates. A forward contract can be termed as a non-standardized agreement between two entities to buy and sell a particular asset at a stated price on a future date (Kwok 21). Forward contracts are among the various tools of hedging adopted by firms. Forward contract shields the firm from suffering losses or having unstable cash flow due to fluctuations of the exchange rate. Essentially, forward contracts eliminate the possibility of suffering a loss caused by fluctuations in the exchange rate. Forward contracts enhance certainty in future prices and therefore budgeting can be made more effectively. A firm can decide to use a full or partial forward cover depending on the anticipated effects of risk and exchange rate trends. The full forward cover involves committing the whole investment to the policy. On the other hand, partial forward cover refers to securing a part of the investment and living the rest uncovered. Herr Ruhnua assessed the situation of Lufthansa and the trends in the foreign exchange rates and identified that partial forward cover befitted the firm. Actually, Herr decided to cover only fifty percent of the total exposure and leave the rest uncovered. A critical analysis of Herr Ruhnua decision reveals that he was optimistic that the exchange rates wound favor the firm in future. Therefore, there was no need to be overcautious in protecting the interest of the firm since, according to him, future market trends were clear. Forward contract fits perfect in times inflation. The term inflation can be termed as the general rise in prices of commodities in the market. Inflation is usually caused by factors such poor economic performance or the fall in the value of the domestic currency. Adoption of forward contracts in investments aids in ensuring that the expenses do not exceed the budgeted amount. Before deciding on the financial risk management strategy to employ, firms must usually assess the inflation rates (Hull 78). Inflation rates are not static and, therefore, change from time to time. In this regard, it is the manager’s responsibility to keep current with changes in the inflation rates. Herr Ruhnua had made wise projections regarding the future trends in the exchange rate. In most case, a steady rise in the value of a foreign currency is usually followed by a fall in value. Even though Herr Rhunua’s projections were valid in terms of currency valuation trends. Unfortunately, the time factor hindered successive maturity of the plans. The action taken by Herr can be explained on the basis of foreign exchange exposure. The foreign exchange exposure assesses the net cash flows and profitability of a firm based on exchange rates (Madura 137). Herr Rhubau had evaluated the foreign exchange exposure for Lufthansa and purposed to implement policies that would improve profitability in the purchase of Boeing jets. Herr Rhubua had anticipated that the future cash inflows would be more than the outflows and, therefore, the firm’s profitability would increase. Most investment decisions are based speculative future outcomes. In essence, all investors commit their money believing that the investment will generate profitable returns. It is imperative to identify that investment is a risk practice and managers must always be ready to accept the outcomes. Some managers fail to pursue profitable investment decision due to the fear of suffering losses. Hampton (209) states that failure should be part of a firm’s investigative strategies for expensive investments. However, failure should be avoided in all ways possible since some various may terminate the operations of a firm completely (Chew 48). Firms must considered the various foreign exchange exposure categories when engaging in international markets (Merna 230). Some of the most important exposure include operating and transaction exposures. Transaction exposure aids in assessing the value of a pending financial obligation obtained before the changes in exchange rates. In essence, transaction exposure is concerned with the changes in cash flows relating to active contractual commitments. The operating exposure is yet another important consideration to have in mind when transacting internationally. The operating exposure evaluates the present value of an enterprise influenced by alterations in future cash flows of a firm. In this regard, the exposure attempts to assess the changes in cash flows caused by uncertain exchange rate changes. Purchase of the Boeing aircraft was not a faulty decision as viewed by the board. Considering the time value for money, the upsurge in price during the time of making payment was expected (Daelen 45). The value for money keeps on changing depending on the international financial markets trends and economic performance. Since the aircrafts were not purchased on cash, changes in the budgeted amount were unavoidable. In essence, the long the time for payment the higher the paying expenses involved. Purchasing the Boeing aircraft was not a mistake; instead Herr was trying to enter the most appropriate deal for the good of the firm. The Boeing Company allowed Lufthansa to pay the total amount in installments. Essentially, the amount of purchasing the jets was very large to be paid at once. In this regard, Herr Rhubau had to accept the deal since it fitted the firm’s financial position at that time. The contract to purchase the aircrafts fulfilled several international parity conditions. For instance, since the aircrafts identical, they were sold at one price (Morales 80). The purchase of a firm’s assets should be based on, among other things, quality, terms and conditions of sale, legal constraints and financial position of the firm. Choosing to buy the aircrafts from America, other than Europe was not a wrong decision. The choice must have been influenced by several factors. For instance, the Boeing Company is known for producing top quality aircrafts. In addition, the deal offered by the company was suitable, bearing in mind sufficient time was given to make payments. Literally, Airbus Company would appear to be favorable for Lufthansa due to close proximity. Considering the terms and condition for payment, purchasing the aircrafts from Airbus company is more expensive that from Boeing Company (Lee and. Lee 344). Companies should be left trade free between countries (Denze l22). Actually, firms should not remain too conservative in buying fixed assets. In essence, quality and favorable terms of sale are some of the basic factors considered when purchasing expensive fixed assets. In addition, the cost of the asset being purchased should be considered to identify where an enterprise can afford to make the payments. Herr Rhubua should be retained because explored the world markets and made Lufthansa known to the Boeing Company. Lufthansa should pride itself for having an explorative chairman who can cross oceans in search of profitable ventures for the firm. Conclusion International financial management is an intensive field that requires a high level of competence and outstanding decision asking skills. Purchase of costly assets should be a well-planned process to avoid losses and critical risks. Managers should be explorative in order to develop effective decision-making skills. Employees and board members should always operate as a single unit in developing financial policies of the firm. When failure of a policy is identified, all parties in the firm should join hands in salvaging the interest of the firm. In summary, managers must possess effective analytical and decision-making skills to avoid losses to the firm. Works Cited: Anderson, Darren. Corporate survival: the critical importance of sustainability risk management. New York, NY: iUniverse, 2005. Print. Ayse, Cyrus. Risk Management and Corporate Sustainability in Aviation. New York, NY: Ashgate Publishing, Ltd., 2012. Print. Chew, Donald. Corporate Risk Management. New York, NY: Columbia University Press, 2013New York, NY. Print. Daelen, Michale. Risk Management and Corporate Governance: Interconnections in Law, Accounting and Tax. New York, NY: Edward Elgar Publishing, 2010. Print. Denzel, Markus A. Handbook of World Exchange Rates, 1590-1914. Farnham, Surrey, England: Ashgate, 2010. Print. Hampton, Justus. 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