Westwood Plastics Inc. Foreign Currency Risk Hedging Strategies Jason Cowne Kazuo Shirai Yen-nhi Do Julie Nguyen Chatree Jirakranjanavanit FIN 570 Dr. Greco July 6, 2009

Outline Economic Outlook Company/Case Background Define the issue Products Industry Define the issue Transaction Risk Analyze the case data Basic Issues Immediate Issues Cause/Effect Diagram Critical Exchange Rate Exchange Rate Trends Generate alternatives Select decision criteria Analyze & evaluate alternatives Conclusions

Case Data Analysis -Economic Outlook Year 2005 Year 2006 Year 2007 Year 2008 Real GDP Growth CAD % 2.4 2.9 2.7 Real GDP Growth EUR % 2.3 3.3 2.5 2.2 Inflation CPI CAD % 3.4 3.1 Inflation CPI EUR % 2.0 1.8 1.9 Unemployment CAD % of labor force 7.0 6.8 6.4 6.0 Unemployment EUR % of labor force 6.7 7.5 6.9 6.6 CAD Long-term interest rates 4.1 4.2 4.3 EUR Long-term interest rates 3.8 Source: CIA World Factbook

Company Background Westwood Plastics Core competency – Manufacture & sales of proprietary plastic products in Canadian marketplace. License Agreement with Schalle Industry (Cologne, Germany) Exclusive manufacturing and distribution rights to Cryolac

Schalle Industrie (AG) Case Background Westwood Plastics Payment Loan Schalle Industrie (AG) Canadian Bank Payment is a note (9.1%, n = 10) Financing from two sources: Schalle & bank Revenue is in CAD Expenses is in EUR The right to manufacture & distribute premium product, Cryolac Mfg. Cryolac

Company Background - Cryolac Products Dough Box White Cryolac Plastic ABS Plastic manufacturing processes: 1. Injection Molding II. Extrusion Molding Cryolac is a specialized proprietary plastic

Company Background -Plastic Industry Over 3,400 companies Employing 113,000 workers $33 billion Canadian dollars in Total Revenues 85% of plastics exports are bound for the U.S. Lowest production costs for the plastics sector among G7 countries

Define the Issue Time frame: March 01, 2006 Revenues are in CAD Expenses are in EUR Currency market is highly volatile Effects of depreciating CAD currency Pay more EUR Understand effects of income & cash flows (Projected fiscal 2007 results)

Define the Issue Projected EBT is $12 Mill CAD @ EUR=$1.3536 CAD Loan covenant EBT > $9 Mill CAD Understand tools to manage currency exposure Recent trend shows CAD appreciating If CAD depreciates, projected EBT not met

Define the Issue - Transaction Risk A large portion of its expenses are paid in EUR All of the company’s revenues are denominated in CAD A monthly licensing fee of 250,000 EUR Raw materials necessary for the manufacturing of Cryolac Costs of servicing: 1 million EUR note for partial payment of the upfront licensing fee

Analyze the Case Projected EBT@ CAD $1.3536/EUR Projected Expense in CAD $ 49,944,000(will pay in EUR) Converted to EUR 36,897,163 at the budgeted exchange rate of 1.3536 CAD/EUR Budgeted EBT (CAD/EUR) CAD $62,002,000-CAD $49,944,000 = CAD $12,058

Case Data Analysis - Basic Issues IMPORTANCE URGENCY LOW HIGH

Case Data Analysis - Basic Issues IMPORTANCE URGENCY LOW HIGH Economic Risks

Case Data Analysis - Basic Issues IMPORTANCE URGENCY LOW HIGH Economic Risks R&D in Domestic

Case Data Analysis - Basic Issues IMPORTANCE URGENCY LOW HIGH Economic Risks R&D in Domestic Shipment Risks

Case Data Analysis - Basic Issues IMPORTANCE URGENCY LOW HIGH Economic Risks R&D in Domestic Shipment Risks Increasing market shares

Case Data Analysis - Immediate Issues IMPORTANCE URGENCY LOW HIGH

Case Data Analysis - Immediate Issues IMPORTANCE URGENCY LOW HIGH Political risks

Case Data Analysis - Immediate Issues IMPORTANCE URGENCY LOW HIGH Political risks Competitors

Case Data Analysis - Immediate Issues IMPORTANCE URGENCY LOW HIGH Political risks Competitors Understanding the effect of currency exposure

Case Data Analysis - Immediate Issues IMPORTANCE URGENCY LOW HIGH Political risks Competitors Understanding the effect of currency exposure Currency Exchange Risks

Cause/Effect diagram Comparing the decision criteria Currency trends The best alternative hedging strategy for the company Measurement of hedges and exposures Sources of financial restriction facing Westwood

CAD per 1 EUR Exchange Rate Chart (Jan 1999 – Jan 2006) Trend Line

CAD per 1 EUR Exchange Rate Chart (Jan 2005 – Jan 2007) If CAD continue to appreciate against EUR at present rate, then year end EBT will be C$13,069 thousand.

EBT forecast without hedge (Assume exchange rate move on 3/1/06 and stay at level) €/C$ exchange rate 1.3336 1.3536 1.3736 1.3936 1.4136 1.4365 Revenue (C$) 160,000 COGS (€ component) 45,084 45,760 46,436 47,112 47,788 48,562 COGS (C$ component) 67,935 Gross Margin 46,981 46,305 45,629 44,953 44,277 43,503 License Fee (€) 4,001 4,061 4,121 4,181 4,241 4,310 Depreciation (C$) 9,640 Selling and Admin. (C$) 19,232 Interest (€ component) 121 123 125 127 128 131 Interest (C$ component) 1,191 Total expense 34,185 34,247 34,309 34,371 34,432 34,503 EBT 12,796 12,058 11,320 10,582 9,844 9,000

1.4365

Generate Alternatives Hedging Vehicles Call Option Premium Put Option Forward Contract Margin – 8% of face value

Decision Criteria Alternatives Decision Criteria Risk Cost Profit Flexibility Put Option High ( - ) Medium (0) (+) Call Option Low ( + ) Forward Contract (-) None Highest – Medium - Lowest Use of Put option is speculative! 29

Analyze & Evaluate Alternatives Call Options Put Options Forward Contract Cost = 50,960,000 (1,016,000 + 49,944,000) CAD Premium % of EBT = 8.4% = 49,944,953 (953,000 + 49,944,000) CAD Premium % of EBT = 7.9% = 50,343,412 CAD

Analyze & Evaluate Alternatives Hedge method Up-font Hedge Cost (Premium) Margin Req. Average balance Loss of interest income Hedged EBT Potential Loss if rate is Potential Loss Amount Potential Gain if rate is 1 No Hedge - > 1.3536 Unlimited < 1.3536 2 Buy Call Option 1,016 11,042 None < 1.3260 3 Enter into Forward Cont. 2,186 109 11,659 4 Buy Put Option 953 < 1.3278

Conclusions Westwood Plastics will use the call option as the optimal hedging strategy Call Options Advantages Doesn’t tie up a lot of capital Limits potential losses without limiting potential gains

Historical Exchange Rate Trend (Jan 2004 – Jan 2009)

Questions???