Question

8. Suppose GM is considering buying a plant in Hungary. All sales will be to Hungarian customers and

denominated in forints. The projected returns and investments are as follows:

i. Purchase price 30 billion forints

ii. Additional investment $50 million, all imported from U.S.

iii. Projected Hungarian sales 45 billion forints

iv. Projected earnings 4.5 billion forints

v. Exchange rate 300 forints/$

a) What is the total investment in dollars?

b) Once the plant is up and running, what is the annual percentage return on investment?

c) If the forint is devalued 25%, what is the new exchange rate?

d) If this 25% devaluation was made after the purchase and additional investment were completed, what is the new ROI?

e) Instead of selling to the Hungarian market only, suppose all sales were exports, priced in hard currency, yielding the same 4.5 billion forints earnings (at the original 300 forints/$ exchange rate.) If the 25% devaluation now occurred, what would happen to the plant’s profit margins?

Answer 1

a) What is the total investment in dollars?

300 forints = 1 $

So 30 billion forints = 100 MILLION $

Now total investment will be purchase price + additional investment = $100 million + $50 million = $150 million

b) Once the plant is up and running, what is the annual percentage return on investment?

Annual % return = Net income / Investment

Net income = 4.5 billion fortis = 4.5 x 1,000 / 300 = 15 million $

Hence, annual % return = 15 / 150 = 10.00%

c) If the forint is devalued 25%, what is the new exchange rate?

Forints is devalued by 25% hence, new exchange rate = old rate + 25% of 300 forints = 300 + 75 forints = 375 forints per US $
d) If this 25% devaluation was made after the purchase and additional investment were completed, what is the new ROI?

Net income = 4.5 billion fortis = 4.5 x 1,000 / 375 = 12 million $

Hence, annual % return = 12 / 150 = 8.00%

e) Instead of selling to the Hungarian market only, suppose all sales were exports, priced in hard currency, yielding the same 4.5 billion forints earnings (at the original 300 forints/$ exchange rate.) If the 25% devaluation now occurred, what would happen to the plant’s profit margins?

The profit margins will increase. Export currency will be dollar So, all the revenues will be received in dollar. As domestic currency has depreciated, the $ when converted to domestic currency will translate into higher value in terms of domestic currency and hence it will result into higher margins.