Recommended Format of the Project Analysis [No need to follow!!]
Part I: Introduction (background analysis)
Part II: Models (like valuation model, pricing model, exchange rate determination model, exposure measurement and management model, etc…)
Part III. Results (your empirical analysis and explanations);
Part IV. Conclusions (to summarize main results);
Part V. Appendix (basically spreadsheets/tables/figures);
Part VI. References (if any, like newspapers, journals, articles, etc)
The bottom line is that you have to answer all 5 questions (page 2 of this Instruction) based on the given assumptions and cash-flow structure (page 3 of this Instruction).
In case you need to make additional assumptions necessary for you to solve the problems, please state clearly those in the written report.
Tips listed in page 4 of this Instruction offer some useful guidance to conduct analysis.
The report should be double-spaced, 11- or 12- font-sized, and four-to-ten-page long (not including spreadsheets/tables/figures/references).
Instructions for Case “Jaguar plc, 1984”**
In July 1984, the British Government decided to privatize Jaguar plc. Jaguar sold over 50 % of its cars in the United States, but its production was confined to Britain, so it was subject to considerable exchange rate exposure. Your task is to take into account the exposure in pricing the shares of Jaguar and value how much the firm is worth under several exchange rate scenarios.
Below is a list of questions you must address in your case analysis. For each answer, be sure to attach spreadsheets showing how you obtained the answer and describe any relevant calculations in your write-up. Be sure to be as clear and concise as possible.
Discuss about Jaguar’s exchange rate exposures. (5’’)
To which currencies is Jaguar exposed? (1’’) What are the sources of these exposures? (4”)
How much is Jaguar worth in sterling at the beginning of 1984? (10”)
In order to focus on the issues related to risk management we provide a spreadsheet that with a framework for the valuation and the projected free cash flow for 1984 (see Jaguar.xls and the assumptions used in the next page). To finish the valuation you should make your own assumptions for 1985 and beyond. In particular, you should determine what are reasonable forecasts for the value of the $/£ rate.(20”)
Furthermore, thoughts must be given to how these exchange rates will affect the prices and quantity of Jaguar cars sold in the U.S.(10”)
3) (20”) You are a security analyst responsible for following Jaguar's stock after it floats. (Assume the company had 100 million shares outstanding.)
What is your estimate of Jaguar's stock price given a 10% drop in the real value of the dollar?(5”)
What is Jaguar’s market value exposure (and delta) with respect to the real dollar/sterling exchange rate? (5”)What is Jaguar's free cash flow exposure (and delta) for the years 1985 to 1989 with respect to the real dollar/sterling exchange rate? (5”)
Discuss the economic reasons for the size of this exposure. (5”)
Discuss how Jaguar could manage this exposure using forward contracts.(5”)
What type of positions would they take and for how long?(5”)
Consider the exposure (delta) of Jaguar to the $/£ rate for a U.S. investor rather than a U.K.investor (10”).
Is the exposure to the dollar-based owners the same as that of the pound-based investors above? Why or why not? (10”)
ASSUMPTIONS AND CASH FLOW STRUCTURE
Fixed Costs - Capital expenditure is assumed to be £11.5 million in 1984 and rises by 15% per year. Depreciation for 1984 is assumed to be £10 million (approximately 10% of fixed assets at beginning of 1984) and continues at 10% of the running balance of fixed assets plus capital expenditures each year. R&D is £18.0 million in 1984 and rises at the growth rate of total sales (in £). Distribution and administrative expenses (both assumed to be fixed costs) rise at the inflation rate from their 1983 figures of £13.3 and £22.0 million respectively.
Variable Costs - All of the “costs of sales” in the income statement, net of depreciation, is (arbitrarily) assumed to be variable costs. Variable costs/unit rise at the inflation rate. Note that the 1983 volume used to determine unit costs should be production volume of 28.041, not sales volume.
Net Working Capital - NWC in 1983 is unrealistically low for a stand-alone company. Assume that the balance in the NWC account is topped up to £30 million in 1984 and then grows at the growth rate of total revenues thereafter (the net addition each year from cash flow is the current balance times the % change in total sales).
Other assumptions - Assume a tax rate of 35%. We used a growth rate of 12% over unit sales in 1983 in estimating the 1984 sales figures. The appropriate sterling discount rate is 18%, based upon average levels of inflation over the past few years. Finally you may treat sales to the “rest of the world” as denominated in £ so as to eliminate the need to directly model other non-$ currencies. Pound inflation is forecast to continue at around 5% into the foreseeable future. U.S. inflation is anticipated to average 3% per annum into the future. Indicate explicitly what your assumptions are about Jaguar unit sales growth for the future. 4
SOME USEFUL TIPS:
1) Exchange Rate Exposure: Transaction exposures and Economic exposure.
2) “Worth” means Value of Asset. Procedures of calculating Value of Asset can be found in the PPT.
3) The value in spreadsheet is “in thousand”.
l For the data of 1983
4) Dollar/sterling of 1983 is available in Exhibits 7. ( Use the fourth quarter exchange rate of 1983)
5) “$ price/unit” is assumed to rise at the inflation rate.
6) NWC is available in Exhibit 1.
7) R&D is available in Exhibit 2.
8) Depreciation is available in Exhibit 2, notes (a).
9) “Total sales, units” can be found in Exhibits 3.
10) “Var. cost sales” is available in Exhibit 2. Note: cost of sales=369.7-8.6=361.1
11) Inflation rate of US and UK in 1983 is available in Exhibit 8.
12) EBIT is available in Exhibit 2.
13) Tax rate is 35%.
14) Increase NWC is the difference between 1983 NWC and 1982 NWC.
15) Capital Expenditure is the difference between Fixed Assets of different years.
16) Discount factor is 1/ (1+18%).
17) Value of firm=PV FCF-long term debt ( long term debt is available in Exhibit)
18) Terminal Valuet = CFt+1/(k-g) where K=18%, and g=12%.
l For the estimate from 1985 to 1989
1) Use PPP to estimate the exchange rate. For example:
2) Assume long term debt and liabilities have not changed.
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