1. 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

2. 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

3. 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

4. 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

5. 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

6. 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

7. 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

9. 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)

10. 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

11. 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

12. 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 CAD/EUR
Budgeted EBT (CAD/EUR)
CAD $62,002,000-CAD $49,944,000 = CAD $12,058

13. Case Data Analysis - Basic Issues
IMPORTANCE
URGENCY
LOW
HIGH

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

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

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

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

18. Case Data Analysis - Immediate Issues
IMPORTANCE
URGENCY
LOW
HIGH

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

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

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

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

23. 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

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

25. 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.

26. 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

27. 1.4365

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

29. 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

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

31. 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 -
>
Unlimited
< 2
Buy Call Option
1,016
11,042
None
< 3
Enter into Forward Cont.
2,186
109
11,659 4
Buy Put Option
953
<

32. 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

33. Historical Exchange Rate Trend (Jan 2004 – Jan 2009)

34. Questions???