Decision Making: Based on Exchange Rates - Assignment Example

Corporate Finance al Affiliation) Decision Making: Based on Exchange Rates Companies strive to maximize utility at the lowest cost possible. The major responsibility for a finance manager is to seek purchasing alternatives with the highest comparative advantage. In this case, the company (based in UAE) required purchasing equipment worth AED50million from a foreign supplier. The supplier gave a quotation for the equipment both in Great Britain Pounds and Eros. In addition, it would cost the company AED 5million to bring the equipment to the required location in the UAE. However, the transportation cost was to be paid to a UAE transportation company. It was prudent, as the finance manager, to make a transaction decision that had the highest competitive advantage. The decision would be based on the exchange rate for both currencies based on the AED. By monitoring the exchange rate for a period of five days, it was evident that the best decision would be established. In addition, monitoring the exchange rate for both currencies in relation to the AED provided the opportunity to establish the best possible currency to use; the most stable among the two. a) Check the exchange rate for a period of five days and create a table of comparisons of how much will be your AED50m worth on each of the five days in both Euros and GB pounds. Choose the currency you will use for your transactions. Table 1: The Exchange rate both in GBP/AED and EUR/AED from 24th December to 28th December (XE Live Exchange Rates, 2014) 24 25 26 27 28 GBP/AED 5.7116 5.71448 5.71145 5.71493 5.71485 EUR/AED 4.48053 4.49005 4.47894 4.4747 4.4747 Table 2: Value of AED 50 millions in relation to the exchange rates above 24 25 26 27 28 AED 50M GBP 8,754,114 8,749,702 8,754,344 8,749,013 8,749,136 EUR 11,159,395 11,135,733 11,163,355 11,173,933 11,173,933 Decision on the Currency to Use Considering the purchasing power parity, the law of one price states that similar goods should have a similar price after taking into account the exchange rate. This is before transportation costs have been incorporated to the cost of bringing the goods to the desired location. In this case, the Great Britain Pound will be used for the transactions because there are minimal deviations in the exchange rate from 24th December to 28th December. In addition, the exchange rate is stable as opposed to the Euro. After making the decision to use the GBP, it is prudent to indicate the value of £860,000 in AED. Table 3: Value of £860,000 in AED for each of the five days 24 25 26 27 28 Supplier’s Quotation £860,000 £860,000 £860,000 £860,000 £860,000 Exchange rate 5.7116 5.71448 5.71145 5.71493 5.71485 Cost in AED *The Exchange Rates are based on XE Live Exchange Rates, 2014 b) Calculate how much it will cost the company in Dirhams to buy the equipment on the first day of monitoring the exchange rate. Explain the impact of your action. On the first day of monitoring the exchange rate; Purchasing the equipment on the first day would save the company. That would be a great deal considering that the exchange rate was favourable. c) Calculate how much it will cost the company in Dirhams to buy the equipment on the second day of monitoring the exchange rate. Explain the impact of your action. On the second day of monitoring the exchange rate; Purchasing the equipment on the second day would save the company As the finance manager, the option maximizes utility, but at a relatively higher cost compared to the first day of monitoring the exchange rate. d) Calculate how much it will cost the company in Dirhams to buy the equipment on the third day of monitoring the exchange rate. Explain the impact of your action. On the third day of monitoring the exchange rate; Purchasing the equipment on the third day would save the company Contrary to the savings on the first and second day; the third day proves to have AED124 and AED2, 606 more savings respectively. The third day would be the best option because the exchange rate maximizes utility at the lowest cost. e) Calculate how much it will cost the company in Dirhams to buy the equipment on the fourth day of monitoring the exchange rate. Explain the impact of your action. On the fourth day of monitoring the exchange rate; Purchasing the equipment on the fourth day would save the company The savings are the lowest as compared to those that would be made in the first, second, and third day. f) Calculate how much it will cost the company in Dirhams to buy the equipment on the fifth day of monitoring the exchange rate. Explain the impact of your action. On the fifth day of monitoring the exchange rate; Purchasing the equipment on the fifth day would save the company The savings are relatively lower than those on the first and third day. Although the option maximizes utility, it does so but at a relatively higher cost. g) Write a report to support your decision for the transaction you have done. In your recommendation outline what makes your decision the best for the company. Consider every day you were monitoring the currencies as the day you made the decision and purchased that equipment. Was that the best decision and why? Capital Budget Introduction Considering that the equipment was a significant element of production, it would be essential to obtain it by the beginning of 2015. However, the most prudent decision would be to monitor the performance of both the euro and Great Britain Pounds. Such a comparison diversified the options available for making the transaction. As the finance manager, the best option for the company was the one that reaped the highest utility at the cheapest cost. It was found that the Great Britain pounds gave a competitive advantage over the euro. The GB pounds indicated a stable trend throughout the five-day period. On the other hand, the fluctuations in EUR/AED discouraged further considerations for the euro to be used for the transactions. In addition, the five-day period acted as a time series model to establish the behavior of the quoted prices in relation to the exchange rate. Discussion The foreign supplier offered a £860,000 and €1,090,000 quotations for the equipment. However, the quotation was valid for seven days after which it expires. It would have been prudent to take the shortest time possible to monitor the exchange rate to establish the rate that offers a competitive advantage. After settling on the GB pounds, the quotation in British pounds was evaluated for a period of five days. It should be noted that the days spent on monitoring the exchange rate honoured both the validity of the quotation and the days required for transporting the equipment. All the dates would provide ample time for the quality department to assess the effectiveness of the equipment and order for any repairs, training, or both. Therefore, 24th December to 28th December was the best possible dates to weigh all the options available, in relation to the exchange rate. There were no deviations in the transportation cost as it was paid directly to a UAE transportation company. Therefore, the transportation cost was a fixed cost whereas the cost of the equipment varied according to the exchange rate. On the first day of monitoring the exchange rate, the equipment was worth. The decision to purchase the equipment on this day was effective but hurried. It would not have been prudent to assess the performance of the exchange rate for five days then make the decision to make the transaction on the first day. As a finance manager, speculation can offer a competitive advantage over avoiding risk. Therefore, it was prudent to assess the cost of the equipment on the other four days, in relation to the exchange rate. The second day of monitoring the exchange rate did not offer a competitive advantage. The exchange rate was relatively higher than the first day. The cost of the equipment amounted to The speculation process was limited by the possibility that the AED would worsen and lose value in the remaining days. It was wise to purchase the equipment on the second day. In addition, the equipment would have arrived in UAE early enough to allow for quality checks according to the specifications. Contrary to the trend between the first and second day, the third day proved to be promising. The AED improved, reporting an exchange rate of GBP/AED 5.71145. The exchange rate led to savings amounting to the third day was the ideal day for the purchase. The savings were higher than those reported on the first and second day. Speculation involves taking risks and being optimistic. The fourth day would prove to be the best day possible to purchase the equipment. The exchange rate placed the equipment at a value of. The fourth day would be the best day because the equipment would arrive early enough for the necessary checks. However, the savings reported () were not competitive enough compared to the other three days. The final day of monitoring the exchange rate seemed to offer some competitive advantage. The value of the equipment amounted to The decision to purchase the equipment on the fifth day was prudent because it would have arrived in UAE early enough for quality checks. However, assessing the cost savings among the five days proves that the fifth day did not offer sufficient competitive advantage. Recommendation Cost savings are a sufficient indicator of the purchasing decision to be implemented. Therefore, an analysis of the savings based on the exchange rates from the 24th to 28th December provides multiple options to choose from. As the finance manager, the third day was the best day possible to purchase the equipment due to the following reasons; The equipment would arrive in UAE early enough for the relevant quality checks to be undertaken and The exchange rate on the third day offered a relatively higher competitive advantage compared to the first, second, fourth, and fifth days. In addition, the exchange rate led to higher cost savings compared to the other days. In addition, finances are resources, which are known to be scarce. It is prudent to utilize resources in an efficient manner; that is, maximizing utility with every unit of finance spent. Therefore, the third day obeys the law of utility and offers the highest competitive advantage in relation to the cost of the equipment. The process was successful because the company achieved its objective; which was to maximize utility at the lowest cost possible. Read More