Diva Shoes Inc. Harvard Case Solution & Analysis

Diva Shoes Inc. Case Study Solution 

Diva Shoes Inc. sales have started to increase and the company has been generating revenues of around 2.47 billion JPY in Japan that is equal to 25 million USD. This has increased the foreign exchange exposure faced by the company by 14% approximately. Previously, all the adverse currency movements were absorbed by the company profits, however, the currency exposure has now increased and thus Lisa and Bisno needs to hedge the exposure. Two alternatives have been evaluated and Lisa and Bisno are recommended to hedge through currency options because of the unlimited profit potential and limited loss. The revenues would be slightly low under options than forwards but is more beneficial for Diva Shoes.

Problem Diagnosis

Diva Shoes Inc. is the manufacturer of the luxury shoes for women based on United States. The foreign exchange exposure facing the company has started to increase and so far the President and the chief executive officer had not attempted to devise any hedging strategy within the company. This was because small currency depreciations and adverse movements in the currency exchange rates were absorbed by the high profits of the company.

However, the exposure had now increased especially in Japan where the sales of the company have reached to a high level of JPY 2.47 billion that is equal to 25 million in USD. There was no reason to believe that the current exchange rate between Japanese Yen and USD would remain stable in the future years also. Therefore, we analyze two hedging alternatives for the firm, forwards and options and then recommend the best course of action to Benjamin Bisno.

Case Analysis

We first begin the analysis by determining the projected profits for Diva for the year ending September 1995.

Projected Profits for Diva for Year Ending September 1995 (Question 1)

We have computed the projected profits for Diva Shoes in September 1995 based on the estimated revenues for the company as shown in exhibit 4 in the appendices. Since, we need to project the profits, therefore, we projected the net margin ratio from exhibit 5 and assumed it to be same in 1995 at 9.10%. The projected profits for the company in September 1995 are $ 4587708 as shown in exhibit 1 in the appendices.

Factors Affecting Exchange Rate Risk Exposure of Firms (Question 2)

The factors that affect a firm’s exchange rate risk include the economic stability of the country, translation exposure, transaction exposure and the historical volatility of the exchange rate movements. The volatility of the exchange rate movements is same as the transaction exposure. This arises from the transactions that are conducted in other currencies and sales and payments are made in other currencies.

 

Diva Shoes Inc. Harvard Case Solution & Analysis

 

The translation exposure is the risk of the losses due to the translation of the foreign financial statements to the domestic currency. This occurs when all the profits, revenues, expenses and the liabilities of the operating company or operations are translated to the parent company’s basis. The macroeconomic trends and the political instability of the foreign countries can have a significant impact on the currency rate exposure of the firms. This gives rise to economic exposure. All the factors impact on the exchange rate risk of the firms.........................

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