Nodal Logistic and Custo Brasil
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After approval from the company’s executive board, John Penman knew that Nodal Logistics Corporation could invest in a $45 million industrial property of 800,000 square feet in Sao Paulo, Brazil. This represented an important long-term opportunity because the company’s global position could be greatly improved. However, the problem appear when Nodal Logistics’ legal department received a notification from their Sao Paulo based associate saying that, under Brazilian Law, all commercial real estate contracts must be denominated in Brazilian Reals.
Nodal Logistics Company is interested in entering the Brazilian market, because it is an emerging market, as it has important factors as population, skilled labor, and especially the geographical strategic point on partnerships in the Mercosur also is a great disadvantage that the exchange rate will face the American company with the Brazilian currency, the real. This is because the law marks all trade and investment has to be in its national currency and seek a return of less investment in five years, but with this action investment real an estimated 12 years would and also a devaluation risk in the Brazilian currency. He also hired an investment company which issued the following requirements must have the new American enterprise.
*Register at the Central Bank of Brazil
*Ask to remit funds from a non-Brazilian company as dividends and fees.
*Not required to pay double taxation of dividends.
*Build your estate 150 miles offshore.
*All port terminals are privatized.
*It is by law required that foreign companies have strategic alliances joint ventures with local partners.
All these key pieces made decisions that the property would be in Las Campinas, near Sao Paulo place will also be taken. And also Nodal is concerned about the value generated over year from the Brazilian Prohect, the Real is continually appreciating against US dollar over the last 5 years but economic and financial conditions are always uncertain and more in a foreign country in Latin-American and any adverse fluctuations in exchange rates can substantially threaten the projected cash flow. This project might pose Nodal to face currency risk in two different ways. 1. Initial execution of contract in BRL, although $45 million is a huge investment and any adverse changes in exchange rate fluctuations can significantly impact the cash flows of the company. 2. The project is expected to generate regular in an easy way a cash flows in local currency that will be converted periodically in US dollars, for its distribution to shareholders, which can threaten cash flows in the long term. So that Nodal´s Company consider adopting an appropriate hedging technique to avoid the negative effect of currency risk.
Nodal´s Company needs to face for the international trade that currency exchange rates will change after the company have already entered into financial obligations in Brazil so they need to minimize all the exposure, such to fluctuating exchange rates can lead to major losses for firms.
Also as is a company with a business model where you get a little more than 75 % of its profits from the property income property or these distributed 90 % of the profits of the current period as dividends to its shareholders and face no income payments. That is the end result they want is to return the most dollars for them without a loss or risk from its investment in Nodal´s, which is what faces the exchange rate real.
On the other hand it is important to analyze the tax granted for the Brazilian government for the company, which has to be competitive for the company, so that the free utility tax will be high, and after the property has to function as planned 2009, they can earn an income before taxes of $5 million Reals, which is an equivalent of $ 2,800,000.00 USD. (Taking into account the exchange rate at $ 1.795). And you have to statistics that the effective tax rate would be 24%. The risks of this investment look beyond the appropriate rate for the investment to make, but Nodal acquires assets in a foreign country has to adapt to the economic conditions of purchase and especially develop business in that country without modifying the initial investment and it is much the impact of currency fluctuations where these actions is no longer good for business, cannot take their assets and retire, but has to evaluate all assets and sell the real estate. But before that happens and for proper economic performance of real income derivatives, must be exchanged for dollars in each period, to distribute investment and benefits, in order to reduce risks.
Take the currency risk, and buy real, hoping it will appreciate in future. This seemed to be a favorable option because the real had consistently appreciated against the dollar over the past three years, and macro volatility is low and economic policy is sound although the fiscal and external solvencies are now a non-issue and the balance of payments is being backed up by strong inflows of dollar.
Forward contract. Lock in an exchange rate with the bank until a certain future date, with currency projections against the spot rate though. In this case had an option to have Forward contracts, which allow Nodal fixed exchange rates in the future at no charge, the bank may impose a fee upfront for contracts deadlines because Nodal has a predetermined line of credit. But by large amounts involved to cover investment in Brazil can to ensure the currency. Use currency Put Options to lock in a minimum rate of exchange, if the real of Brazil, plummets in value against the US dollar. But this creates a problem though if the real rises in value against the US dollar and Penman already picked a floor that was too low, this would leave a higher percentage of the factories vacant.
Sharing the currency risk with a type of tenants for the real estate or currency Adjustment Clauses, this would allow tenants and Nodal to agree on the exchange rate for a certain period or percentage fluctuation in the strike price. Problems arise with this kind of solution, as many tenants may not want to sign currency agreements and this would leave a higher percentage of the factories or leases. Financing a portion of Nodal´s debt in the construction of the property with real, in an attempt to reduce the “total equity risk and exposure”. This does not seem to be a good idea, as the Brazilian exchange rate quoted was a five year fixed rate. Nodal can swap a portion of US dollars for real consistently over time, trying to “desensitize” Nodal in movements of the real.
If in this case the project is not as essential for Nodal company and they want to ensure first against exchange rate fluctuations and movements as it could be a good solution to go out there at the risk and considering simply that there is no better justification according to the actual historical trend in Brazil is appreciating and taking a stable against the US dollar. If you think that the Brazilian real may remain fixed on the market with a value of $ 1,795 against the dollar. And as seen in the case analysis where the analysis of accumulated cash flows for the first six years will be a total of $ 15,126,195 US dollars and with a current value of $ 10,279,691 US dollars.
And moreover if the real appreciates against the dollar in the long term future then Nodal Company would be in a better position to enjoy and would need less real for $ 1. But if Real depreciates against the dollar, the scenario would be but long term taking their threatened flows, with a change of 5 % of the total investment of $ 45 million, an amount of $ 8,409,066 would be obtained with -18 % uncertainty. In contrast to the above, although exchange rates fluctuate continuously with the timeline there is a very distinct possibility that exchange rates can appreciate or depreciate over time so a calculation in Exhibit 2 to 5% so a possibility of appreciation or depreciation of the exchange rate at 5% annual, with a degree of uncertainty a little high uncertain -15%.
If we claim to be expected that the Real is to appreciate against the dollar that 5% then relates to the exhibit 1 showing that cash flow accumulated during the first six years of Nodal will result in a total of $ 18,554,307 US dollars with a value $ 12,500.647 current increasing with a total growth of + 21 % , well above this . And if the Brazilian real against the dollar depreciates the 5% , then the cash flow accumulated during the first six years is recorded anyway totaling $ 12,261,289 US dollars and a current value of $ 8,409.066 with a smaller decline of -18 % of the reference index .
Nodal Logistic´s future strategy, will should be about protecting earnings. The real can fluctuate wildly but it only affects Nodal once converted back into dollars, each period and every period to meet REIT requirements for profits distributions. So that´s why purchasing currency options, seem the smartest option for me. However to mitigate some of the risk involved with the US dollar to real exchange, a shorter maturity date should be negotiated with the Nodal Logistics bank, in this case Ney York bank, that would reach maturity at the end of the five year period, therefore reducing the outlay of capital the inherent risk.
Moffet, Micheal (2008) Nodal Logistics and Custo Brasil. Thunderbird. School of Global Management. Investopedia (2013) Transaction Exposure. Investopedia. Recovered at 19 of February at: http://www.investopedia.com/terms/t/transactionexposure.asp