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Foreign Exchange Transactions

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Problem 11.3 Seattle Scientific, Inc.

Josh Miller is chief financial officer of a medium-sized Seattle-based medical device manufacturer. The company's 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 Yokasa's cost of capital.

Assumptions Values
Seattle's 30-day account receivable, Japanese yen 12,500,000
Spot rate, ¥/$ 111.40
30-day forward rate, ¥/$ 111.00
90-day forward rate, ¥/$ 110.40
180-day forward rate, ¥/$ 109.20
Yokasa's WACC 8.850%
Seattle Scientific's WACC 9.200%
Desired discount on purchase price by Yokasa 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

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

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Solution Summary

The solution computes Seattle Scientific, Inc's amount it will receive in $ if payment is received in cash.