Business Resources - Assignment Example

?Business Resources Table of Contents Overview 3 1 Evaluation of the four Options in light of recent development in European Economies 4 11 Analysis of Investment Strategy 1 4 1.12 Analysis of Investment Strategy 2 4 1.13 Analysis of Investment Strategy 3 5 1.14 Analysis of Investment Strategy 4 5 1.2 Recommendation of Best Strategy for Expanding and Supplying the Four Target Markets 6 2.1 Current Economic and Market Conditions in the Euro Zone 6 2.2 Strategies to Manage Foreign Exchange Exposure 9 3. Factors to Be Considered While Conducting Investment Appraisal for the Strategies 11 References 15 Overview Elecdyne Wales is a South Wales-based electronic goods producing company that had been instituted as a spinoff from a Japanese electronics company and the Celtic University of Technology. The objective of Elecdyne Wales is to develop patentable electronic goods making use of leading edge telecommunications and multimedia technologies and market them in the European Union region. Elecdyne Wales wants to increase its extent of production as it wants to supply its goods in the United Kingdom and Germany this year, and France and Italy in the following year. Thus, the company has to make certain strategic investment decisions and it has four different strategies to choose from. The first option is to expand the existing production capacity at South Wales and reinforce its export function. The second option available is to form a strategic alliance with a European supplier or distributor. The third option is to shift its production base to a location in the European Union region, while the fourth option is to shift production to Central and Eastern European Countries (CEEC). This paper appraises the strategic investment options available to Elecdyne Wales in context of the latest economic developments in the European region, and recommends the best strategy to cater the markets of UK, Germany, France and Italy. The papers also discusses the existing economic and market circumstance in the Euro zone and proposes both short-term as well as long-term strategies for the company to manage foreign exchange exposure. Additionally the paper also accentuates on the factors to be considered while carrying out the investment appraisal of the last three options available to Elecdyne Wales. 1.1 Evaluation of the four Options in light of recent development in European Economies 1.11 Analysis of Investment Strategy 1 The first strategic option of the company is to expand its existing production capacity at South Wales and strengthen its export function. Implementation of this strategy would enable the company to have superior control over its goods manufacturing process and also save the company from economic exposure of an overseas region. Moreover the company would not require additional capital investments to set up a new unit and it would also not lose its technological knowledge and expertise to its foreign associates. Thus, the strategy of reinforcing its existing manufacturing facility would ensure that the company maintains its technological edge in addition to having more operational flexibility. Nevertheless, there are certain drawbacks of this strategy. Since the company is looking forward to export its products to the European markets, carrying out the production in South Wales would rule out the understanding of the European culture and market specifics, in addition to higher costs of manufacture and haulage. Thus, though the strategy gives certain short-term benefits such as no additional production set-up investments, minimal exposure to translation and economic exposure and manageable foreign exchange risks; the strategy can be termed as defensive in the long run and it would keep the company away from cost competition (Gillespie et al. 2010). 1.12 Analysis of Investment Strategy 2 The second alternative available is to form a strategic alliance with a European supplier or distributor. If the company opts for this strategy it would gain from the existing network and the market knowledge of the supplier. Moreover, implementation of this strategy would require limited resources and investment from Elecdyne Wales. However, the company would be exposed to foreign exchange exposure along with supply chain hazards. The risks could be both internal and external in nature. For instance, the brand image of the company and the smooth conduction of business in the European markets would depend on the new associates of the company, thus exposing it to internal risks (Dicken, 2003, pp. 247-250). 1.13 Analysis of Investment Strategy 3 The third choice is to shift its production base to a location in the European Union region. This strategy would enable the company to have more control over the quality and operations of the business. Moreover, it would have access to skilled workers, superior infrastructure, government subsidies and other technological support. The European market is a huge market and carrying out the production there would give the company cost advantage. However, the political, social, environmental, legal and the economical issues of Europe would have a direct impact on the business of Elecdyne in this case, thus exposing it to further foreign exchange exposure. 1.14 Analysis of Investment Strategy 4 The fourth alternative available to Elecdyne Wales is to shift production to Central and Eastern European Countries (CEEC) such as Hungary, Romania, and Czech Republic among others. These nations are particularly viable in context of costs as against other European states. Furthermore, the availability of highly skilled workers in addition to the geographical benefits of the region makes the strategy of building up a production base in the CEEC very competitive. Nevertheless, it should be noted that the government incentives to the CEEC have been continuously declining and there is a strong likelihood that the labour charges of these countries would be set as per the European Union norms (Dummler & Kienle, 2008; Bussiere et al. 2005). This would possibly elevate the investment expenditure as well as the overall risk exposure of the company. 1.2 Recommendation of Best Strategy for Expanding and Supplying the Four Target Markets The thorough analysis of the four strategies reveals that in the short-term, considering the volatile economic and market conditions in Europe, it would be advisable for Elecdyne Wales to develop its existing production unit at South Wales and build up its export operations. This is because this strategy would provide the utmost flexibility of operations and also expose the company to the least amount of foreign exchange risk. However, in the long run, the company should think of forming a tactical alliance with a supplier in the Euro zone. This would not only help the company to efficiently reach out and cater to the need of the European markets, but also control its risks owing to the existing base of the European alliance. Thus, implementing this strategy would give almost the same benefits as setting up a production base at Europe, but at a much lower expense as well as risk. 2.1 Current Economic and Market Conditions in the Euro Zone The European Union has 27 member nations, out of which seventeen have formed the “Economic and Monetary Union” (EMU) and have chosen the euro as their one and only currency. These countries are collectively known as the Euro zone. On the basis of gross domestic product (GDP) and proportion of global trade and investment, the Euro zone is as good as that of the United States. Hence, these countries are a crucial participant in the world economy (Ahearn et al. 2012). The instability associated with the future of the Euro zone started in the beginning of 2010 as a consequent of the commencement of a sovereign debt emergency in Greece. As a result, there were concerns that Ireland, Portugal, Spain, and Italy were also deficient in maintaining sustainable financial positions. Markets were apprehensive of potential defaults and hence began demanding significantly elevated interest rates for their bonds (European Commission, 2012). The debt issues of the nations constituting the Euro zone represent a severe hazard to the banking system of Europe, the feasibility of the Euro, in addition to the European integration procedure (Ahearn et al. 2012, pp. 8-13). The debt and banking problems of the Euro zone had been amplified owing to the feeble growth in region in addition to a mild recession projection for 2012. As on January 13, 2012, the credit ratings of many European nations including France, Italy, and seven others were lowered by the Standard & Poor’s. This down-gradation of the credit rankings served as a supplementary factor to the crisis in the region. One of the primary and vital reasons for the crisis arises from faults in the construction of the currency union. This includes the fact that the EMU involves a common central bank, namely, the “European Central Bank” (ECB), and as a consequence a common monetary policy; nevertheless the EMU does not prescribe for a common fiscal policy and instead leaves it to the individual member nations (Ahearn et al. 2012, pp. 5-7). The inferior enforcement of fiscal discipline over the years, added to the increasing public debts in some of the European nations. Since, the members of the Euro have a single currency; the individual members are not able inflate their way out of huge public debt or undervalue their currency to make their exports more viable (Ahearn et al. 2012, pp. 15-17). As Elecdyne Wales is based in South Wales, where the adopted currency is the British Pounds (GBP), the choice of investment strategy would be influenced by the relation between the values of Euro as against the British Pound. The figure below illustrates the values of British Pounds to Euro during the last 120 days. Figure: British Pounds to 1 Euro (Source: X-Rates, 2012). The base currency used in this graph is the Euro, while the target currency is the British Pound. The latest value of 1 Euro in terms of British Pounds as on April 3, 2012 was 0.8354 GBP, while the lowest and the highest during the last 120 days were 0.8240 GBP (as on January 9, 2012) and 0.8793 GBP (as on October 28, 2012) respectively (X-Rates, 2012). It can be observed from the graph that the value of Euro had continuously declined against that of the British Pound over the 120 days period. 2.2 Strategies to Manage Foreign Exchange Exposure Since Elecdyne Wales is located in South Wales, England, its home currency is the British Pound. Nevertheless, as the company wants to export its goods to European countries like France, Italy and Germany, it would have to deal with Euro as well. Thus, Elecdyne Wales would be exposed to the foreign exchange exposure, which is actually the risk associated with exchange rate movements. Owing to its overseas business operation the assets and liabilities of Elecdyne Wales as well as their cash flows are expected to be maintained in different currencies. The variations in the exchange rates of British Pound and the Euro might unfavourably impact the reported earnings and the supposed net worth of Elecdyne Wales. As a result of foreign exchange exposure, the cash inflows as well as outflows from the overseas business operations in Europe can be unfavourably affected when valued at British Pound, which is the domestic currency for Elecdyne Wales. Again, the settlement value of Euro dominated contracts, for instance loans in Euro, when valued in British Pounds can be detrimental to Elecdyne owing to the exchange rate fluctuations. The sources of foreign exchange exposure for Elecdyne Wales in the four optional investment strategies are overseas sales operations, overseas production facilities, outsourced facilities or support, and supplier relationships among others. In general there are three different kinds of foreign exchange exposures, namely transaction exposure, economic exposure and the translation exposure (Ajami et al, 2006, pp 110-111). Elecdyne Wales would be exposed to transaction risk when it would get engaged in current business transactions involving Euro (which is a foreign currency for the company). Thus, the company would be open to transaction risk, whatever might be its choice of investment strategy. This is because all the strategies would involve Elecdyne in foreign currency transactions. The transaction exposure of the company can be managed by entering into forward contracts, futures, options and other money market hedges in addition to currency swaps (Sullivan, 2009, pp. 342-345). If Elecdyne Wales chooses the third or the fourth investment strategy and sets up manufacturing units in another foreign region, it would expose itself to translation exposure. Translation exposure would take place as an effect of the fact that Elecdyne, which is the parent company in this case, would have to merge all of the operations of its manufacturing units in Europe and South Wales into its own accounting statements. Since the assets of the production units in the Euro zone or the Central and Eastern European nations would be carried on their accounting books in terms of Euro, it will be essential to translate the Euro values of the assets into British Pound values for merging with the parent company’s assets. The varying currency exchange rates lead to the occurrence of gains or losses for the period of the translation process. In view of the fact that this exposure is associated with the assets and liabilities of the company as mentioned in the balance sheet, it is frequently termed as accounting exposure. The long term involvement of Elecdyne Wales in the markets of Europe would exposure it to the economic uncertainties of the European region, thus divulging the company to economic exposures. Elecdyne Wales can take certain measure to hedge against the economic exposures. It could diversify its product sourcing or move its production base. Both these measures are effective because when the sales value decline owing to the appreciation, the company can benefit from less expensive cost of production by shifting manufacturing activities or material sourcing to other regions where the currency is comparatively weak. Thus, it can be said that geographic diversification is beneficial in hedging economic exposure to a considerable extent. Conclusively, the short term strategy of Elecdyne Wales for managing foreign currency exposure would be to engage in financial derivatives such as forwards, futures as well as options. On the other hand, the company should think of diversification in terms of material sourcing, production and distribution as a long-term strategy to tackle foreign currency exposure. 3. Factors to Be Considered While Conducting Investment Appraisal for the Strategies For the investment appraisal of the options available to Elecdyne Wales, the management needs to take both the qualitative and the quantitative factors into consideration. The quantitative factors to be taken into account during investment appraisal are the payback period, the net present value (NPV) and the internal rate of return (IRR) generated by the different options. These quantitative measures offer a numerical foundation for decision making on the basis of monetary value place on the different options (Lumby, 1988, p. 474). Nevertheless, the quantitative data only provide a part of the story and hence it is important to take the qualitative factors into consideration as well. The ultimate decision depends on the balance amongst the perceived effects of the qualitative as well as the quantitative factors. The qualitative factors can be understood by undertaking the analysis of SWOT, PEST and stakeholders for each of the available investment options. Qualitative factors also include industrial relations and the exchange rates prevailing in addition to the state of economy in the region. These factors take into account the qualitative issues that could impact the consequence of an investment choice. The SWOT analysis of the various investment options available to the company enables it to compare the options more comprehensively. Another vital factor that influences the overseas investment decision of a company is the external factors surrounding the target market (Gotze et al., 2007, p. 121). For instance, the political, economical, social and the technological factors prevailing in the Euro zone are likely to impact the outcomes of Elecdyne Wales’ choice of investment strategy. The most crucial factors that the management team of Elecdyne Wales have to consider while undertaking the investment appraisal for options 2, 3 and 4 are inflation rates, national incomes, government policies and foreign exchange rates (Madura, 2009, pp. 39-40). Impact of Inflation If the rate of inflation of a particular nation rises in comparison to that of the nations with which it conducts business, then it is likely that the current account of the nation would decline, other factors remaining the same. In such a circumstance, the customers as well as the business houses in that nation would buy more number of products from a foreign country. At the same time the level of exports of the nations to the overseas markets would reduce to a large extent owing to the high rate of domestic inflation (Madura, 2009, pp. 39-40). Impact of National Income If the income level of a nation rises at a higher rate than those of other nations, then its current account is likely to decline, other factors remaining stable. With the increase in the real income level of a nation, this is attuned for inflation; the level of consumption of goods also increases. A fraction of that increase in expenditure will most probably be a sign of an augmented demand for overseas products (Madura, 2009, pp. 39-40). Impact of Government Policies The government of a nation can have a strong influence on the qualitative aspects of investment appraisal, by means of its guidelines on subsidising exporters, limitations on imports, or requirement of enforcement on piracy. At times, the government provides subsidies to the country-based organizations enabling them to manufacture goods at a lesser expenditure than their international rivals. This increases the export demands of these organizations. At the same time, the government can also check the imports from other nations. Such type of trade restrictions are generally in the form of tariffs and quotas (Madura, 2009, pp. 39-40). Impact of Exchange Rates The currency of each nation is valued in relation to the currencies of other nations by means of the exchange rates. International trade and transaction require currencies to be exchanged. The values of majority of the currencies vary over a period of time owing to the forces pertaining to the market and the government policies. When the value of the currency of a particular nation rises in comparison to other currencies, then its current account balance declines. This is because as the value of the currency appreciates, the products sold by that nation to other overseas nations would become more costly to the importing nations. As a result, the demand of the products of that nation will decline leading to reduced balance in its current account. For instance, during the end of 2008, the currency exchange rates of the Euro currencies fell considerably in comparison to that of dollar. The euro currencies comprised of euro, British pound, Swiss franc and Hungarian forint. As a result of the decline in the values of euro currencies, the cost of the European goods deceased from the point of view of the American customers. Simultaneously, the cost of goods manufactured in the US augmented from the viewpoint of the European buyers (Madura, 2009, pp. 39-40). References Ajami, R. A. et al., 2006. International business: theory and practice. USA: M.E. Sharpe. Ahearn, R. J., et al. 2012. The future of the Eurozone and US Interests. 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Sullivan, D., 2009. International Business. India: Pearson Education. X-Rates, 2012. British Pounds to 1 EUR. [Online] Available at: http://www.x-rates.com/d/GBP/EUR/graph120.html [Accessed on April 4, 2012]. Read More