The Procter & Gamble Company

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Case study

at BI Norwegian Business School

- Case 1: The Procter & Gamble Company: Mexico 1991-

Exam code and name:
GRA 6544 – Multinational Corporate Finance

Hand out date:
11.09.2012

Hand in date:
25.09.2012

Study place:
BI Oslo

Table of Contents
Abstract:ii
1. Mexican economic conditions1
a. Change in Mexican economic and political conditions during the 1970s and 1980s1
b. Mexico’s economic and political climate in 19912
2. Financing options2
3. Financing risk, foreign exchange risk and business risk8
4. Attractiveness of Mexico’s capital market9
5. Conclusion:10
References:11

Abstract:
Procter & Gamble (P&G) needs to borrow an average of $55 million over the next three years in order to expand and modernize its Mexican subsidiary. As four financing alternatives are currently available to the company, our analysis focuses on the several factors that could affect P&G’s final decision. Both the lowest cost of raising capital and an acceptable level of risk are at the basis of P&G Mexico’s rationale. Market factors include different interest rate levels, the Mexican tax law, devaluation probability and returns in Mexican money-market investments. Country-specific factors include the Mexican economic and political environment. Given that interest rates in US dollars are significantly lower than in Mexican pesos, we compare the four financing options by also taking into consideration the positive returns provided by Mexican economic policy regarding domestic investments in monetary assets. We conclude with a sensitivity analysis of our assumptions by highlighting the prominent role played by estimated devaluation and the decline in Mexican interest rates. 1. Mexican economic conditions

a. Change in Mexican economic and political conditions during the 1970s and 1980s Mexico continued its trend of significant economic growth and prosperity throughout most of the 1970s. Now, as opposed to the last 40 years of growth after the Great Depression, the main driver was the discovery of the enormous Chiapas oil field, which brought with it a massive influx of foreign loans. This decade was, however, also characterized by a rapid increase in inflation, which forced the government to devalue the peso by as much as 58% in 1976. A twenty year long era of fixed exchange rate had come to an end. To prevent capital flight when investors confidence disappeared, the Mexican government froze all hard-currency payments and converted all debt owed to foreign creditors into pesos. In addition, all principal repayments on this debt were deferred for five years. (Robert Looney, 1985)

Highly expansionary fiscal policy reinforced further growth, but also made the peso chronically overvalued. This, together with the resulting unmanageable high levels of external debt, forced the country to undergo several peso-devaluation during the early 1980s, and in 1982 an unavoidable debt crisis occurred. At this point in time the booming days were definitively over and the Mexican investment climate had been significantly deteriorated. In 1982 the oil-price bubble burst and the rest of the Mexican economy collapsed. The unemployment and inflation rate skyrocketed with the country experiencing zero-growth in GDP. (Robert Looney, 1985)

At the end of the 1980s the Mexican economic policy was trying to combine a number of government/labor/private sector issues with traditional austerity measures where wage, price and exchange rate controls were predominant. Investors slowly regained their confidence and the inflation was reduced, generating a net inflow of capital and thus avoiding a sharp long-lasting recession. The level of external debt, as a ratio of GDP, fell considerably (by 11%) from 1989 to 1991 and throughout the whole decade of 1980 a massive number of state-owned firms were privatized. (www.mongabay.com)

b. Mexico’s economic...
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