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Josh Miller is chief financial officer of a medium-sized Seattle-based medical device manufacturer. The
companys annual sales of $40 million have been growing rapidly, and working capital financing is a common
source of concern. He has recently been approached by one of his major Japanese customers, Yokasa, with a
new payment proposal. Yokasa typically orders 12,500,000 in product every other month and pays in Japanese
yen. The current payment terms extended by Seattle are 30 days, with no discounts given for early or cash
payment. Yokasa has suggested that it would be willing to pay in cash in Japanese yen if it was given a 4.5%
discount on the purchase price. Josh Miller gathered the following quotes from his bank on current spot and
forward exchange rates, and estimated Yokasas cost of capital.
Assumptions
Seattle's 30-day account receivable, Japanese yen
Spot rate, /$
30-day forward rate, /$
90-day forward rate, /$
180-day forward rate, /$
Yokasa's WACC
Seattle Scientific's WACC
Desired discount on purchase price by Yokasa
Values
12,500,000
111.40
111.00
110.40
109.20
8.850%
9.200%
4.500%
Josh Miller should compare two basic alternatives, both of which eliminate the currency risk.
1. Allow the discount and receive payment in Japanese yen in cash
Account recievable (yen)
Discount for cash payment up-front (4.500%)
Amount paid in cash net of discount
Current spot rate
Amount received in U.S. dollars by Seattle Scientific
12,500,000
(562,500)
11,937,500
111.40
107,158.89
12,500,000
111.00
112,612.61
0.9924
111,755.82
2. Not offer any discounts for early payment and cover exposure with forwards
Account receivable (yen)
30-day forward rate
Amount received in cash in dollars, in 30 days
Discount factor for 30 days @ Seattle's WACC
Present value of dollar cash received
Josh Miller should politely decline Yokasa's offer to pay cash in exchange for the requested discount.
Evaluation of Alternatives
Values
7,000,000
33.40
32.40
1.500%
8.000%
not available
200,000
Cost
Certainty
209,580.84
Risky
216,049.38
Risky
216,049.38
Certain
7,000,000
0.9963
6,973,848
33.40
208,797.85
8.000%
1.0200
212,973.80
Certain
The currency risk is eliminated, but since Susan Takaga would have to exchange the money up-front, it would require her to
borrow the money, increasing her debt outstanding for the entire 3 months.
Discussion.
This is a difficult decision. The forward contract appears to be the preferable choice, protecting her against an appreciating T$,
and creating a certain cash purchase payment. The problem, however, will be whether the Bank of Hawaii will allow her to
purchase a forward for the full $216,049.38, which is slightly above her credit line currently in-place. If her relatonship is
good with the bank, they most likely would increase her line sufficiently to allow the forward contract.