Managing Resources in the International Business Environment1. Introduction
This report provides information about project viability after considering the economic situation of the US and the UK. Also calculated net present value to determine the profitability of two given projects. Also, discussed mitigation techniques in the fluctuation of exchange rates. A recommendation is made after analysing the net present value.
A combination of factors including economic growth, market demand, financial stability etc, will affect the viability of a project. Therefore, an organisation must assess the risks associated project before taking any new initiatives. Organisations may use Investment appraisal techniques to assess the risk and generate higher returns. In the given case net present values are used to assess the viability of two projects.
At present quarterly annualised GDP growth rate of the USA was revised up from 4.9% to 5.2% due to higher-than-expected fixed investment and government consumption. For this reason, export growth and private consumption are revised. On the other hand, due to strict credit requirements, a slower unemployment growth rate, the start of student loan repayments, and an automotive sector strike that will last until the end of October, it is likely that the economy is losing momentum (focus-economics.com, 2023). Along with three dimensions including resilience of the labour market, growing economic out and slowing inflation, the US economy outperformed as expected in the financial year 2023. The latest World Economic Outlook which is released by the IMF represent that it is a crucial opportunity to evaluate the US economy's performance in light of the world economy (Bureau of Economic Analysis, 2022). The progress which the US economy has achieved in terms of inflation, labour markets and growth is notable worldwide and it provides support to the world economy.
Diagram 1: GDP 2023 vs. 2019
(Source: focus-economics.com, 2023)
A flat (0.0% growth) GDP rate represented by the UK in the 3rd quarter of 2023 as compared to the 2nd quarter of 2023. Additionally, the overall GDP in the Eurozone reduced by 0.1% in the fiscal year 2023. However, service output and manufacturing output increased by 0.5% and 2.3% respectively. Productivity across the UK declined by 0.2% due to the unemployment rate reaching 4.2% (clearcurrency.co.uk, 2022).
One out of two given projects may be acceptable if the return on investment is higher as compared to the bond yield of the USA (3.89%) and the UK (3.53%).
One out of two given projects may be acceptable if the return on investment is higher as compared to the bond yield of the USA (3.89%) and the UK (3.53%).
Conversion from Euro to GBP | |||
Year | Cash Flow (Euro) | Exchange Rate (1 USD = 0.78 Pound) | Cash Flow (GBP) |
0 | 20 million | 0.87*20 | 17.4 million |
Initial values of the Europe project are converted into UK currency to determine how much GBP currency will be needed by the company to invest in the USA and Europe projects. In the determination of initial investment value in GBP use the spot rate. The current amount that one currency will swap for another at a given moment is known as the spot rate. This easily method to method to convert one currency to another currency and the liquidity of the currency is higher for this reason, exchange transactions are quickly complete (Du, and Pentecost, 2021). Investment and financial transactions between currency traders, organisations and countries are settled through the spot rate which is regulated by the global foreign exchange market. Therefore, the company needs £17.4 million GBP to invest in the Europe project.
Calculation of Net Present Value | ||||||
| Project A (USA) | Project B (Europe) | ||||
| Discount Factors @3.89% | CF | DCF | Discount Factors @3.53 | CF | DCF |
|
| $ (million) | $ (million) |
| £ (million) | £ (million) |
Year 1 | 0.963 | 2.00 | 1.93 | 0.966 | 2.00 | 1.93 |
Year 2 | 0.927 | 4.00 | 3.71 | 0.933 | 3.00 | 2.78 |
Year 3 | 0.892 | 5.00 | 4.46 | 0.901 | 4.00 | 3.57 |
Year 4 | 0.858 | 6.00 | 5.15 | 0.870 | 8.00 | 6.87 |
Year 5 | 0.826 | 8.00 | 6.61 | 0.841 | 8.00 | 6.61 |
|
|
|
|
|
|
|
Total DCF |
|
| 21.85 |
|
| 21.75 |
Initial investment |
|
| -20.00 |
|
| -17.4 |
Net present value |
|
| 1.85 |
|
| 4.35 |
Conversion of GBP to USD | (1 Euro = 1.27 USD) |
|
|
|
| 5.52 |
The net present value of the two projects is calculated to determine the profitability and viability. The net present value of the Europe project is converted into USD values which represent the net present value of the USA project is USD 1.85 million and the Europe project is USD 5.52 million. Thus, the net present value of the Europe project is higher as compared to the USA project.
The comparative price of one country’s currency is explicit in terms of another country's currencies, which refers to the exchange rate. The exchange rate refers to the significant variable of the economy of a country who are actively involved in international trade. The exchange rate is affected by many factors including government stability, economic reports, central bank monetary policy, interest rate and inflation rate. The change in government policy may lead to the depreciation of the domestic currency. Thus, domestic currency depreciation will affect living standards, and increase inflation and economic growth (Reserve Bank of Australia, 2020). Foreign direct investment may be affected by government policy because interest rates may increase resulting increase in foreign investment because foreign investors seek to invest capital when the interest rate is higher but all are managed by the inflation rate. Therefore, it is necessary for foreign investors to predict the exchange rate using the supply and demand model, the purchasing power parity, interest rate parity and balance of payment approach etc. In the foreign exchange market, buyer-seller interaction is currency price which is assumed by the supply and demand model (OZDOGAN, 2022). In terms of purchasing power parity, the buying power of two currencies should be equalised in terms of a shared basket of goods and services when their exchange rate is equal.
Any international business’s profitability and efficiency are seriously affected by currency risk. The financial risk called foreign risk arises from the variations in trade between the local currency of a country where businesses are conducted and home currency. The exchange rate fluctuation risk may be managed using different financial instruments including currency options, futures exchange contracts and forward exchange contracts.
Currency option
Obligation does not arise but it provides the right to sell or buy currency at a particular time using a specific rate. Forward exchange contracts and currency options are similar but in the case of currency options, transactions are not forced to be completed if the contract expiry date arrives. Thus, investors can take advantage of these contracts if the exchange rate is favourable as compared to the spot rate (corporatefinanceinstitute.com, 2023).
Forward exchange contract
It is an agreement between two parties where foreign currency is sold or bought on a future date at a predetermined date. Therefore, forward exchange contracts provide assistance to prevent loss which may arise due to the fluctuation of foreign currency exchange rates. The contract is intended to hedge a foreign exchange position to prevent a loss on certain transactions (Liao and Zhang, 2020). For example, suppliers provide 3 months of credit to businesses. If businesses purchase equipment of $10000 through a forward exchange contract and the current GBP/USD is $1.27. Thus, businesses have to pay £7874 to suppliers.
The net present value is called capital budgeting techniques which can be used to accurately measure any project profitability. It is because it shows the difference between the present value of future cash inflow and outflow by using the time value of money. The initial cost of Euro projects is converted into GBP value by using the forward exchange rate to determine the initial cost GBP value. Additionally, the bond interest rate of the UK is 3.53% which is used to determine discount factors for the Europe Project and the USA project is 3.89%. In net present value calculation discounting factors as major variables to determine the present value of earnings.
A project is acceptable if the net present value is positive. In the given case, the net present value of the two projects is positive. However, the net present value of the USA project (USD1.85 million) is USD 3.63 million lower as compared to the Europe project (USD 5.52 million). Also, the company has to incur higher investment costs if they start the project in the USA. Therefore, it is recommended to invest in the Europe project to generate higher returns.
The UK and the US economic scenario are analysed to determine the given project's viability. The net present value represents that the profitability of the UK project is higher as compared to the US project. Exchange rate fluctuation can be mitigated through forward exchange contracts and currency options.
Bureau of Economic Analysis (2022). U.S. Economy at a Glance | U.S. Bureau of Economic Analysis (BEA). [online] Bea.gov. Available at: https://www.bea.gov/news/glance.
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Du, W. and Pentecost, E.J., 2021. New “News” for the news model of the spot exchange rate. Economics Letters, 200, p.109770. https://repository.lboro.ac.uk/articles/journal_contribution/New_News_for_the_news_model_of_the_spot_exchange_rate/17040344/1/files/31547960.pdf
focus-economics.com (2023). United States Archives. [online] FocusEconomics. Available at: https://www.focus-economics.com/countries/united-states/.
Liao, G. and Zhang, T., 2020. The hedging channel of exchange rate determination. International finance discussion paper, (1283). https://drive.google.com/file/d/1Ao75lYCuBVHW8Ykd8oeVxssMTxhUEJT5/view
OZDOGAN, Z., 2022. An Analysis of Exchange Rate Pass-Through to Domestic Prices: Evidence from Turkey. Eurasian Journal of Business and Economics, 15(29), pp.67-86. https://ejbe.org/index.php/EJBE/article/view/758/439
Reserve Bank of Australia (2020). Exchange Rates and their Measurement | Explainer | Education. [online] Reserve Bank of Australia. Available at: https://www.rba.gov.au/education/resources/explainers/exchange-rates-and-their-measurement.html.
Van Nostrand, E. (2023). The U.S. Economy in Global Context. [online] U.S. Department of the Treasury. Available at: https://home.treasury.gov/news/featured-stories/the-us-economy-in-global-context.
