FIN 570 Case Study

October 6, 2008 Riley Drake Fazal Khan Matthew Hemenez

Introduction

 Tranzonic Companies / Hospeco Specialty Company  Crosswell International & Hector Lans  Latin America and Brazil (Mathieux Bros.)

Brazil Markets

 1980’s - Johnson & Johnson introduce the Disposable Diaper  1990’s - Increased competition, new entrants (25% Annual growth)  Segments − Foreign: Local production (40%) − Homegrown (30%) − Argentina: Mercusor (20%) − Foreign Imported (10%)

Brazilian Economy (1995)

 The Real Plan - 1994  Currency Exchange Rates − Crz2,750/US$ -> R$1.00/US$ − R$0.93/US$ (1995)  Inflation Rates – 50% -> 2% per month  Savings/Loans – 3-4% & 8-9% per month Stable

Historical Exchange Rate

Value of One Brazilian $R $US

$1.30

$1.20

$1.10

$1.00

$0.90

$0.80

$0.70

 Value of $R to the US Dollar has been fairly stable since Jan-94

Entry in Brazilian Market

 Establish contract with distributor for “Precious Line of Diapers”- Material Hospitalar  Determine method of operations and associated risks  Determine target market segment  Establish price of product to consumer

Considerations

 Crosswell to ship FOB  Payment to be made in US$ to Crosswell − Cash in Advance − Confirmed Documentary Letter of Credit  Establish Price − Crosswell R$92.21

− Hospitalar R$83.00

US Company CROSSWELL US Sales Reps MATHIEUX BROS.

Exchange Rate Risk

Brazilian Distributor MATERIAL HOSPITLAR Brazilian Retail Outlets

Issues

Not Urgent I Mercosur III Distribution in Brazil Urgent II Foreign Currency Risk V Pricing of Products

Cause and Effect

Causes

Financing costs too high Differing interest rates Differing inflation rates

Effect

Taxes and tariffs Exchange rate risks Examples  2% Import Duty  25% Merchant Marine Renovation Fee   2% Customs brokerage fee 15% Industrial product tax Price of product is too high for Brazil market.

Alternatives

 Do nothing to reduce price  All parties reduce margins  Eliminate or reduce distributor financing costs  Capitalize on interest rates

Decision Criteria

 Select the alternative that: − Ensures a <$83 per case price − Ensures that margin objectives are met at each channel tier.

− Sufficiently addresses exchange rate risk.

 All three criteria must be met

US Company CROSSWELL US Sales Reps MATHIEUX BROS.

Exchange Rate Risk

Brazilian Distributor MATERIAL HOSPITLAR Brazilian Retail Outlets

US Company CROSSWELL US Sales Reps MATHIEUX BROS.

Exchange Rate Risk

Brazilian Distributor MATERIAL HOSPITLAR Brazilian Retail Outlets -

Alternatives

ORIGINAL

-

PROPOSED

32.57

1.22

3.75%

31.35 $US 31.35

1.02

3.25%

5.18

37.55 $US 0.935 $R/$US 35.11 $R 4.11 11.7% 0.00

0.00%

7.84 20.0% 47.05 $R 47.05

16.80 35.7% 19.16 40.7%

83.01

$R + + + + + + 83.00 $R ?

Special Conditions

Monthly Interest Rates in Brazil

(www.latin-focus.com) 20.0% 18.0% 16.0% 14.0% 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% Borrow ing Rate Deposit Rate US Prime Rate Jan-95 8.4% 3.8% 0.7% Fe b -9 5 Feb-95 10.6% 4.8% 0.8% Ma r-9 5 Mar-95 7.8% 3.5% 0.8% Ap r-9 5 Apr-95 12.6% 5.7% 0.8% May-95 14.5% 6.5% 0.8% Jun-95 18.0% 8.1% 0.8% Jul-95 11.2% 5.0% 0.7% Au g -9 5 Aug-95 8.3% 3.5% 0.7%

Interest Income Possibility

 IF Crosswell opened a Brazilian acct

Brazilian Deposit Account $R

beginning balance collections deposited interest earned converted to $US 3.50% ending balance profit from deposit month1 month2 100,000 1,750 month3 101,750 3,561 month4 105,311 3,686 month5 108,997 3,815 101,750 105,311 month6 112,812 108,997 112,812 3,948 (100,000) 16,760 16.8%  Interest earned in 6 months: 16.8%  Interest earned would offset exchange rate risk

$US

$1.30

$1.20

$1.10

$1.00

$0.90

$0.80

$0.70

Interest Offset

Value of One Brazilian $R

Interest offset for exchange rate risk (-16.8%)  16.8% margin for exchange rate risk via interest offset

Proposed Solution

− Crosswell will reduce its price by 3.75% to achieve $83 retail price per unit − Crosswell retains 16.8% margin against exchange rate risk via interest offset − Under nominal conditions, Crosswell will earn 62% more profit

CROSSWELL FINANCIAL PERFORMANCE SCENARIOS

value of $R incr (decr) price to distributor ($US) normal gross profit (@ 20%) 3.75% discount subtotal

worst

-10% 31.35

6.51

(1.22) 5.29

poor

-5% 31.35

6.51

(1.22) 5.29

nominal

0% 31.35

6.51

(1.22) 5.29

good

5% 31.35

6.51

(1.22) 5.29

interest earned (16.8%) gain (loss) from chg in ExR gross profit realized 5.27

(3.14) 7.42

5.27

(1.57) 8.99

5.27

0.00

10.56

5.27

1.57

12.12

normal gross profit % better (worse) 6.51

14% 6.51

38% 6.51

62% 6.51

86%

best

10% 31.35

6.51

(1.22) 5.29

5.27

3.14

13.69

6.51

110%

Proposed Solution

CROSSWELL

Quoted price Discount price to Mathieux Bros

MATHIEUX BROS.

cost/ case Mathiex commissions other costs price to Distributor

EXCHANGE RATE

MATERIAL HOSPITALAR (dist)

cost/ case importing costs cost of financing inventory distributor margin price to retailer

RETAILER

cost/ case taxes retailer costs & markup price to consumer Target Price Price to consumer Margins Exchange Rate Risk

ORIGINAL

32.57

0.00 0.00% 32.57 $US 32.57

1.50 4.61% 5.18

39.25 $US 0.935 $R/$US 36.70 $R 4.29 11.7% 2.57 7.00% 8.71 20.0% 52.27 $R 52.27

18.66 35.7% 21.28 40.7%

92.21

$R 83.00 $R + -

ADD'L 4% DISC.

32.57

1.30

4.00%

31.27 $US

No Financing Cost

32.57

0.00 0.00% 32.57 $US 31.27

0.94

3.00%

5.18

37.39 $US 0.935 $R/$US 32.57

1.50 4.61% 5.18

39.25 $US 0.935 $R/$US 34.96 $R 4.09 11.7% 2.45 7.00% 6.64

16.0%

48.13 $R 36.70 $R 4.29 11.7% 0.00

0.00%

8.20 20.0% 49.19 $R 48.13

17.18 35.7% 17.33

36.0% 82.63

$R 83.00 $R + 49.19

17.56 35.7% 20.02 40.7%

86.77

$R 83.00 $R + -

PROPOSED

32.57

1.22

3.75%

31.35 $US 31.35

1.02

3.25%

5.18

37.55 $US 0.935 $R/$US 35.11 $R 4.11 11.7% 0.00

0.00%

7.84 20.0% 47.05 $R 47.05

16.80 35.7% 19.16 40.7%

83.01

$R 83.00 $R + + +

Risks

 Brazilian interest rates could drop substantially, & will likely decline steadily as $R value proves to be stable − Crosswell to watch rates closely (at least weekly) − May convert Brazilian deposit amount to $US at any time − Set up ExIm Bank for possible future L/C financing for Brazilian trade − Propose alternative to Crosswell board: 90 day L/C to Brazilian distributor, and distributor earn interest & absorb exchange rate risk

Implementation Plan

1-Aug Hospitalar requests a price from Crosswell 2-Aug Crosswell proposes Brazilian account idea to the board of directors 5-Aug Crosswell's board of directors approves the Brazilian account idea 6-Aug Crosswell establishes Brazilian bank account 8-Aug Crosswell responds, via fax, with an FOB price Miami of 29.31 $R ($US price discounted 3.75 and converted to $R at ExR of .935), in exchange for confirmed 45-day L/C in $R 11-Aug Hospitalar agrees to terms and faxes purchase order to Crosswell 12-Aug Crosswell faxes a pro forma invoice to importer agreeing to price and terms 13-Aug Hospitalar's bank issues L/C and sends advice to Crosswell's Brazilian bank that a L/C has been opened in its behalf, guaranteeing payment in $R within 45 days upon presentation of specified documents.

14-Aug Crosswell's Brazilian bank confirms the L/C.

15-Aug Crosswell turns goods over to freight forwarder for shipment and consigns goods to order of shipper.

16-Aug Shipping company issues bill of lading.

8-Sep Hospitalar receives goods 12-Sep Hospitalar sells goods to retailer and is paid cash by retailer.

27-Sep L/C matures and payment transacts to Crosswell's Brazilian account After Crosswell monitors its Brazilian account and interest rates no less than weekly