Second, a progressive tax was ivied on all remittances in excess of 12% of registered capital, and a fixed 25% tax for remittances greater than 20% of registered capital. Currency Risk: West’s presence in the Turkish market exposes it to currency risk. Since January 1995, the TRY had depreciated against the USED by an average of 14% every 3 months (see Exhibit 1), and by nearly 50% between 1999-2000; Translation Exposure: WEST reports to its US parent company in USED, and is therefore exposed to currency fluctuations in the periodical consolidation of the subsidiary’s financial statements from TRY into SCADS.
Hyperinflation: Turkey is historically characterized by hyperinflation (1 00% in 1994), which shows higher rates for consumer products than for wholesale products (see Exhibit 2). Launched in 2000, the government’s ambitious stabilization program brought monthly depreciation of the TRY, which is still undervalued when compared to the Purchasing Power Parity (PEP) (see Exhibit 3). This program has thus far not shown any positive long-term effects and inflation rates rose once again in 2001. Counterparts Risk: West quasi-oligopolies position in Turkey is likely to be inked to a consolidated network with both suppliers and customers. The entrance of new market players, combined with a change in regulations and competitive imports, may affect the relationships with key counterparts. With these issues in mind, Mrs.. Can should opt for the financing option which: (1) minimizes the cost of capital, (2) better copes with the expected trends in currency depreciation/appreciation, (3) minimizes translation exposure.
Financial Analysis and Translation Exposure WEST has achieved a 30% growth on sales in 2000, while a more moderate bubble-digit growth is forecasted for 2001 (+15%). In the period 1 AAA-2001 B, Profits Before Tax represent 19% of Sales on average, Profit after tax represents 9%, and Profit after translation losses represents 5% (see Exhibit 4). The impact of translation exposures (TRY -10. 8 trillion in 1999 and TRY -17. 6 trillion) creates a translation USED gain for the years 1999-2000 (see Exhibit 5).
In 2000, West’s total assets grew by 43%. 2001 B forecasts a further 40% increase (+70% with the introduction of Equator). Net Working Capital has increased in 2000 by TRY 6 trillion, meaning that the Company’s grog. /the is not totally sustained by its suppliers; a further increase is estimated for 2001 (+TRY 9 trillions with the introduction of Equator) (see Exhibit 6). Net Financial debt has increased by 88% in 2000, due to an increase in both Loans payable and Interception payable (see Exhibit 7).
The Competitive environment: reasons for the introduction of Equator Since its establishment in 1971, WEST has maintained a dominant position in the market for shaving instruments. This stronghold can be largely attributed to favorable contextual conditions, notably continued tariff protection, as well s competitive strengths in advertising and product Translation exposure calculated using the monetary/non monetary method due to Turkeys hyperinflation (see FAST Statement No. 52).
We included interception payable Net Financial Debt pays interests US parent company borrowed amount. 3 innovation. Despite continued market dominance in the face of macroeconomic and regulatory challenges, Wilkinson Sword’s management have foreseen a new challenge in the rise of competitors BIG and Gillette. These late entrants to the Turkish razor market are riding On the Wave of elation of trade restrictions, as the government lowers tariffs to prepare its markets for EX. integration and compliance with WTFO guidelines.
This is reflected in the significant rise of import of goods FOB in the period 1999-2002. Such changes demonstrate the Turkish government’s desire to pursue further integration of its capital market rather than segmentation, moving Turkey more towards being an emerged capital market on the EMCEE continuum. With cheaper cost of capital, West’s competitors will be more inclined to invest in Turkey, putting pressure on West’s market position. Thus, to maintain market share and enhance the competitiveness of West’s offer, Mrs..
Can wishes to introduce the Equator shaving system to provide greater security in their positioning as market leader in Turkey. Project Financing Options Having identified the parameters that might influence the financing decision, Mr.. Joan should value the two different options: Option Cost of Capital + TRY/USED depreciation rate Risks Currency risk Country risk Hyperinflation Translation exposure We should then consider whether where a = depreciation rate = (S(365) – SO) / S(O)
The depreciation rate at which the two options are equivalent is a* = According to interest parity, the forward rate TRUISMS for 2001 F(365) should be equal to: S(O) * (1 ,45/1 ,075) 914,000 4 where S(O) is the TRUSTED spot rate as at the end of 2000 (677,621). Therefore, if the interest parity was respected, a = 34,8% < For each a > option 2 shows a lower cost of capital, while if a < option 1 is the cheaper alternative. We will now examine the effect of fluctuations of the TRO'USD exchange rate.
Scenario A: Appreciation of the TRY against the USED If the TRY appreciates against the LASS, the extension of LASS interception achievable (option 1 ) will be more attractive for WEST as the favorable currency exchange from TRY makes the loan cheaper. In this case, WEST may also benefit from increased import costs and lower FED, making it less likely that West’s competitors will pursue establishment and expansion in Turkey. In addition, since WEST already has established factories for razor production in Turkey, they are less dependent on imports than competitors.
As for option 2, leaving translation exposure aside, WEST would not be directly impacted by an appreciation of the T RL since the loan is also denominated in TRY. Scenario B: Depreciation of the TRY against the USED If the TRY depreciates against the USED by more than 37,5%, option 2 will become the cheaper financing option for Equator. Since the domestic loan is fixed in TRY its value decreases in relation to the inflation-driven prices. Scenario A vs. Scenario B It is important for us to consider the past and future development of exchange rates.
From our previous analysis, we know that the TRY is currently undervalued (see Exhibit 3). For the future development of exchange rates, macroeconomic projections for Turkey show that T RL will more than halve its alee against the USED during the next 3 years. In particular, 2001 average TRIG_/SAID exchange rate is going to be 765774, 19% less than *(365). If the projections are correct, option 1 is going to be even cheaper in the short-run, as the value of a would be lower. 5 However, according to PEP at the end of 2000, the TRY is 1 1,9% undervalued. This leads us to the assumption that the TRY will appreciate in the long term.
Effects Of Options 1 and 2 On Translation Exposure As far as translation exposure is concerned, options 1 and 2 will have the same effects on the Assets side, namely an increase in Fixed Assets and Working Capital. However, the two options will affect the Liability side differently: in fact, the USED denominated interception payable (option 1) will not affect the translation exposure, while in option 2 the translation exposure will be equal to SUDS Therefore, option 2 will create an additional Translation loss/gain of USED – S(O)) depending on if the T RL will depreciate/appreciate against the SAID.
Recommendations In light of these possible scenarios, Mrs.. Can must make a decision based on two interconnected factors -? the duration of the loan, and the company’s version to currency risk. The loan’s maturity will influence the decision to pursue option 1 or 2 in that a short-term loan may not yield the benefits of an appreciation of the T RL that are expected, while a long-term loan might.