Advance Technologies Case Solution And Analysis, HBR Case Study Solution & Analysis of Harvard Case Studies

CASE BACKGROUND:

À Company Profile

Advance Technologies is headquartered in Canada having operations in the industry of manufacturing wide range of plastic products. The company wanted to pursue the strategy that maximizes its competitive edge in proprietary products. To pursue this strategy, the company entered into a licensing agreement with a US based company, Hart industries to manufacture and distribute Cryolac in Canada.

À Foreign Exchange Risk

Advance is exposed to the foreign exchange risks due to entering into licensing agreements with Hart Industries. The company’s major portion of expenses is paid in USD that reduces the company’s revenue. As the Canadian dollar depreciated against US dollar it adversely effects the Advance’s Cash Flows and Profitability.

From the Pro-forma income statement of fiscal year 1993 it is clearly reflecting that Advance is expecting to generate revenue of CAD 160 million, while US dollar expenses are projected to be around $40.598 million and these expenses includes such as:

Raw material purchases from Hart Industries

Monthly installments in US dollar of $250,000 as licensing fee

$1 million as a partial payment of a licensing fee.

À Advance’s Concerns:

Advance Industries took a loan from a bank in order to purchase the Cryolac licensing and for manufacturing equipment and this financing was available to Advance Industries on condition that it would generate a minimum before tax profit of $ 9 million. Hart agreed to take the $1 million upfront fee in covenant note that would be paid in 10 years. The fluctuation in exchange rates caused a concern to arise because of this covenant payment. The major portion of expenses were also having the impact of the Advance’s Cash flows, EBITDA and Net profit that could lead the Advance’s towards default.

SENSITIVITY ANALYSIS:

In order to calculate the Sensitivity without forex hedging of the Cash flow and Net income, forecasted Canadian/US dollar exchange rates are used. The exchange rates are used such as 1.2395, 1.2595, 1.2795, and 1.2995 to calculate the sensitivity of the Advance’s Earnings before tax, Net income and Free Cash flows.

The depreciation of the CAD against the USD has adverse effect on Advance’s Cash flow and Net income. The Canadian dollar depreciated against U.S dollar about 6.56% from 1.2195 to 1.2995 that reduces the free cash flows of the company about 11.37% from $17,136,000 to $15,187,000, company’s EBT depreciates around 26% from $12,493,000 to $9,245,000 and net income depreciates around 26% from $7,496,000 to 5,547,000.

Furthermore, earnings before taxes is projected to around $9.245 million that is the worst case, but even in this worst case company can afford to pay its covenant installments. From this sensitivity analysis, it reflects that Advance Industries has the strong profitability and strong earnings.

HEDGING STRATEGIES:

Advance’s annual spending in the Canadian dollar is around $49,509,000 and in U.S dollar it is around $40,598,000 that is calculated through dividing CAD 49,509,000 by 1.2195 and Cash flows shows the stability through a year. In order to calculate the per month spending of Advance in U.S dollar the US $40,598,000 spending would be divided into months that would result in U.S dollar $3,383,000 per month.

1. AT-THE-MONEY CALL OPTIONS

In this Hedging strategy Advance would hedge its forex exposure by purchasing the call options and it would purchase 12 call options. These call options would be purchased at the current spot rate of 1.2536 with the strike price and these options equals to the amount of monthly U.S dollar cash outflows having an expiry of each month for next 12 months. The result of this strategy would be to set the floor prices against the future purchase cost of U.S dollar at the spot rate.

The cost of 12 option contracts long position would be $1.035 million as option premium. This cost is the Canadian dollar cost that transformed fromthe US dollar amount of 40,598,000. The average call premium cost is 2.034% of 12 call options. In this strategy, in order to purchase U.S dollar Advance would pay a maximum exchange rate of 1.2536 that is equal to the amount of CAD $50,894,000.

By using at-the–Money call option, provides the protection against the foreign exchange rate of 1.2536 Canadian dollar against U.S dollar. If any upside changes incur in Canadian dollar then the company would exercise the option at the strike price. If any downside changes incur in U.S future exchange rates, then Advance would leave the option to expire and purchase the USD from the market at a lower rate which would benefit the company paying the lower amount.

2. HEDGING WITH FORWARD CONTRACTS

In order to hedge the currency risk, Advance would go for the forward contract strategy in which company would purchase the 12 contracts under the expiry terms that each contract would expire in one month period. From this strategy, the forward contracts locks the currency exposure of Advance at the average rate of 1.2719.........................

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