BLADES, INC. CASE
Country Risk Assessment
Recently, Ben Holt, Blades’ chief financial Officer, has assessed whether it would be more beneficial for Blades to establish a subsidiary in Thailand to manufacture roller blades or to acquire an existing manufacturer, Skates’n’Stuff, which has offered to sell the business to Blades for 1 billion Thai baht. In Holt’s view, establishing a subsidiary in Thailand yields a higher net present value than acquiring the existing business. Furthermore, the Thai manufacturer has rejected an offer by Blades, Inc., of 900 million baht. A purchase price of 900 million baht for Skates’n’Stuff would make the acquisition as attractive as the establishment of a subsidiary in Thailand in terms of NPV Skates’n’Stuff has indicated that it is not willing to accept less than 950 million baht. Although Holt is confident that the NPV analysis was conducted correctly, he is troubled by the fact that the same discount rate, 25 percent, was used in each analysis. In his view, establishing a subsidiary in Thailand may be associated with a higher level of country risk than acquiring Skates’n’Stuff. Although either approach would result in approximately the same level of financial risk, the political risk associated with establishing a subsidiary in Thailand may be higher then the political risk of operating Skates’n’Stuff. If the establishment of a subsidiary in Thailand is associated with a higher level of country risk overall, then a higher discount rate should have been used in the analysis. Based on these considerations, Holt wants to measure the country risk associated with Thailand on both a macro and a micro level and then to reexamine the feasibility of both approaches. First, Holt has gathered some more detailed political information for Thailand. For example, he believes that consumers in Asian countries prefer to purchase goods produced by Asians, which might prevent a subsidiary in Thailand from being successful. This cultural characteristic might not prevent an acquisition of Skates’n’Stuff from succeeding, however, especially if Blades retains the company’s management and employees. Furthermore, the subsidiary would have to apply for various licenses and permits to be allowed to operate in Thailand, whereas Skates’n’Stuff obtained these licenses and permits long ago. However, the number of licenses required for Blades’ industry is relatively low compared to other industries. Moreover, there is a high possibility that the Thai government will implement capital controls in the near future, which would prevent funds from leaving Thailand. Since Blades, Inc., has planned to remit all earnings generated by its subsidiary or by Skates’n’Stuff back to the United States, regardless of which approach to direct foreign investment it takes, capital controls may force Blades to reinvest funds in Thailand. Holt has also gathered some information regarding the financial risk of operating in Thailand. Thailand’s economy has been weak lately, and recent forecasts indicate that a recovery may be slow. A weak economy may affect the demand for Blades’ products, roller blades. The state of the economy is of particular concern to Blades since it produces a leisure product. In the case of an economic turndown, consumers will first eliminate these types of purchases. Holt is also worried about the high interest rates in Thailand, which may further slow economic growth if Thai citizens begin saving more. Furthermore, Holt is also aware that inflation levels in Thailand are expected to remain high. These high inflation levels can affect the purchasing power of Thai consumers, who may adjust their spending habits to purchase more essential products than roller blades. However, high levels of inflation also indicate that consumers in Thailand are still spending a relatively high proportion of their earnings. Another financial factor that may affect Blades’ operations in Thailand is the baht-dollar exchange rate. Current forecasts indicate that the Thai baht may depreciate in the future. However, recall that Blades will sell all roller blades produced in Thailand to Thai consumers. Therefore, Blades is not subject to a lower level of U.S. demand resulting from a weak baht. Blades will remit the earnings generated in Thailand back to the United States, however, and a weak baht would reduce the dollar amount of these translated earnings. Based on these initial considerations, Holt feels that the level of political risk of operating may be higher if Blades decides to establish a subsidiary to manufacture roller blades (as opposed to acquiring Skates’n’Stuff). The financial risk of operating in Thailand will be roughly the same whether Blades establishes a subsidiary or acquires Skates’n’Stuff. Holt is not satisfied with this initial assessment, however, and would like to have numbers at hand when he meets with the board of directors next week. Thus, he would like to conduct a quantitative analysis of the country risk associated with operating in Thailand. He has asked you, a financial analyst at Blades, to develop a country risk analysis for Thailand and to adjust the discount rate for the riskier venture (i.e., establishing a subsidiary or acquiring Skates’n’Stuff). Holt has provided the following information for your analysis:
■ Since Blades produces leisure products, it is more susceptible to financial risk factors than political risk factors. You should use weights of 60 percent for financial risk factors and 40 percent for political risk factors in your analysis.
■ You should use the attitude of Thai consumers, capital controls, and bureaucracy as political risk factors in your analysis. Holt perceives capital controls as the most important political risk factor. In his view, the consumer attitude and bureaucracy factors are of equal importance.
■ You should use interest rates, inflation levels, and exchange rates as the financial risk factors in your analysis. In Holt’s view, exchange rates and interest rates in Thailand are of equal importance, while inflation levels are slightly less important.
■ Each factor used in your analysis should be assigned a rating in a range of 1 to 5, where 5 indicates the most unfavorable rating. Holt has asked you to provide answers to the following questions for him, which he will use in his meeting with the board of directors:
1. Based on the information provided in the case, do you think the political risk associated with Thailand ishigher or lower for a manufacturer of leisure products such as Blades as opposed to, say, a food producer? That is, conduct a micro-assessment of political risk for Blades, Inc.
2. Do you think the financial risk associated with Thailand is higher or lower for a manufacturer of leisure products such as Blades as opposed to, say, a food producer? That is, conduct a micro-assessment of financial risk for Blades, Inc. Do you think a leisure product manufacturer such as Blades will be more affected by political or financial risk factors?
3. Without using a numerical analysis, do you think establishing a subsidiary in Thailand or acquiring Skates’n’Stuff will result in a higher assessment of political risk? Of financial risk? Substantiate your answer.
4. Using a spreadsheet, conduct a quantitative country risk analysis for Blades, Inc., based on the information Holt has provided for you. Use your judgment to assign weights and ratings to each political and financial risk factor and determine an overall country risk rating for Thailand. Conduct two separate analyses for the establishment of a subsidiary in Thailand and the acquisition of Skates’n’Stuff.
5. Which method of direct foreign investment should utilize a higher discount rate in the capital budgeting analysis? Would this strengthen or weaken the tentative decision of establishing a subsidiary in Thailand?