EE Finance Assingment Help With Solution
You live in the U.S. You invested $60,000 to establish a business of a language school called EE (Escuela de Engles) in Mexico City, Mexico. You hire local individuals in Mexico who can speak English and train others how to speak English. You have a small subsidiary in Mexico, which has an office and an attached classroom that you lease. Clients can come to your subsidiary for a 1-month structured course in English, taught by your employees. You advertise in the local newspapers to promote the teaching services offered by your business.
You also serve some individuals from Mexico who have taken English classes and want to come to the U.S. for a one-week intense course in which they can improve and practice their English and practice it. All revenue and expenses associated with your business are denominated in Mexican pesos. Most of the profits from the business in Mexico are sent to you by your subsidiary at the end of each month. While your expenses are somewhat stable, your revenue varies with the number of clients who sign up for the English-speaking courses in Mexico.
You only need to know this background so that you can answer the related questions that are asked about your business. Answer each question as if you were serving on the board of your business or as a manager of the business.
Mexican interest rates are normally substantially higher than U.S. interest rates.
a. What does this imply about the inflation differential (Mexico inflation minus U.S. inflation), assuming that the peso interest rate is the same in both countries? Does this imply that the Mexican peso will appreciate or depreciate? Explain.
b. It may be argued that the high Mexican interest rate should entice U.S. investors to invest in Mexican money market securities, which could cause the peso to appreciate. Reconcile this theory with your answer (a). If you believe that the high Mexican interest rate does not entice U.S. investors, explain why.
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c. Assume that the difference between Mexican and U.S. interest rates is typically attributed to a difference in expected inflation in the two countries. Also assume that purchasing power parity holds. Do you think that your business cash flows would be adversely affected? In reality, purchasing power parity does not hold consistently. Assume that the inflation differential (Mexico inflation minus U.S. inflation) is not fully offset by the exchange rate movement of the peso. Would this benefit or hurt your business? Now assume that the inflation differential is more than offset by the exchange rate movement of the peso. Would this benefit or hurt your business?
d. Assume that the nominal interest rate in Mexico is presently much higher than the interest rate in the U.S., which is due to a high rate of expected inflation in Mexico. You consider implementing a marketing campaign in which you would hire a local firm to promote your business, but you would have to borrow funds to finance this campaign. A consultant advises you to delay the marketing campaign for a year, so that you can capitalize on the high nominal interest rate in Mexico. He suggests that you retain the profits that you would normally have remitted to the U.S., and deposit them in a Mexican bank. The Mexican peso cash flows that your business deposits will grow at a high rate of interest over the year. Should you follow the advice of the consultant?
e. You have an opportunity to purchase a private competitor called Fernand in Mexico. You will use only your funds if you decide to purchase the company.
1. When you attempt to determine the value of this company, how will you derive your required rate of return? Specifically, should you use the U.S. or Mexico risk-free rate as a base when deriving your required rate of return? Why?
2. Another Mexican firm called Vascon also considers the purchase of this firm. Explain why Vascon’s required rate of return may be higher than your required rate of return? Is there any reason why Vascon’s required rate of return may be lower than your required rate of return?
3. Assume that you and Vascon have the same expectations regarding the Mexican cash flows that will be generated by Fernand. Fernand’s owner is willing to sell the company for 2 million Mexican pesos. You and Vascon use a similar process to determine the feasibility of acquiring a target. You both compare the present value of the target’s cash flows to the purchase price of the target. Based on your analysis, Fernand would generate a positive net present value for yourfirm. Based on Vascon’s analysis, Fernand would generate a negative net present value for Vascon. How could you determine that the acquisition of Fernand is feasible, while Vascon determines that the acquisition of Fernand is not feasible?
4. Repeat Question c, except reverse the assumptions. Based on your analysis, Fernand would generate a negative net present value for your firm. Based on Vascon’s analysis, Fernand would generate a positive net present value for Vascon. How could you determine that the acquisition of Fernand is not feasible, while Vascon determines that the acquisition of Fernand is feasible?
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