Question

ABC Corporation is a listed company in the business of manufacturing industrial equipment, and is domiciled in Zambia. The Financial Manager of ABC Corporation has identified two projects to finance for the next five years. One project is in Australia and the other project is in Zambia. The total funding required for the Australian and Zambian Project is AUD5 Million, and K35 Million Kwacha respectively. Based on the above information, answer the following questions:

A. Discuss the primary funding sources and instruments available for the Financial Manager to finance these two projects

B. Discuss the potential implications of exchange rate movements, and domestic and global interest rate changes on the cash flows associated with both of these projects, and the subsequent financial performance of ABC Corporation

Answer 1

Note that ABC corporation is domiciled in the business of manufacturing industrial equipment but in Zambia.

The dilemma is that one project is in Zambia and the other project is in Australia.

A))

The financial manager would basically have two broad options when approaching the financing of the two projects

1)Equity - The ABC corporation , if being publicly traded in the stock exchanges of both Zambia and Australia can raise money by issuing shares. The only concern would be the response of the investors and the volumes it will trade for

2)Secondly the ABC corporation can issue debt through a bond or debenture, generally a long term bond where it guarantees the repayment of the borrowed amount to the lenders. The major concern would be the interest rate environments of both Zambia and Australia and of course the credit rsk. i,e the repayment capacity of ABC corporation, commonly observed through the credit rating of the company.

b))

Exchange rate movements- As the company is domiciled in Zambia, when the financial statements are being prepared in the home currency then a stronger Australian dollar would mean lower cash flows when converted to the Zambian currency. Conversely, a weaker Australian dolar would mean higher cash flowswhen converted to the Zambian currency.

Domestic interest rate- If the domestic rates of interest in both the countries where it is operating rises, then they are benefited, as the coupon rate will remain the same compared to the prevailing interest rate, but it will become more difficult to issue newer bonds because investors will expect a higher yield now. When the interest rate of the countries drop , then the company has to shell out higher coupons relatvely to the prevailing intreest rate. In such cases , the company can exercse a call option if issued and choose to raise newer amounts at the lower interest rates.

The global interest rate will also matter as in the global age companies also choose to raise money from global markets and based on the global economc conditions, higher interest rates will generaly discourage the company from raising money. Like in the case of domestic rates, the cash flows of the company will be affected mainly in the interest payments which are generally the coupon payments in case of issuance of bonds. These coupon payments may be relatively higher or lower leading to relatively lower and higher cash flows(as interest from financing is an expense, financing cas flow) depending on the prevailing interest rates as explained in the domestic rates section.