FINC 667 - CASE ASSIGNMENT - AVICULAR CONTROLS AND PAKISTAN AIRLINES
International projects present multinational corporations with many complexities in organizing a profitable transaction structure.Foreign exchange risk is an underlying problem. Credit risk presents another challenge. Payment terms and the certainty of realizing them can be difficult points. Negotiations with foreign corporations and governments, and with agents and intermediaries, present additional challenges. An example of the demanding environment for global financial activities is presented in the case of "Avicular Controls and Pakistan Airlines". It is found in Cases in International Finance on page 40.
Review the case carefully and be prepared to respond to the following questions:
Consider the conflicting responsibilities in Avicular Controls' organizational structure - among the strategic management of the company and the functional areas for marketing and finance. Indicate how these meshed to maximize outcomes for the company's business and how they diverged to create problems interfering with financial management.
The original proposal, which ACI had thought it had negotiated, was for all payments to be made in U.S. dollars. The original contract price would be paid in two installments, 20% on contract signing and the remaining balance would be invoiced at the end of one year upon completion of the cockpit retrofits. It is a bit unclear as to whether the original contract under negotiation had included any type of up-front payment; however, it was evidently smaller than the 20% that is now included in negotiations. The second payment invoice would be due in 180 days. Makran would broker the transactions for a standard 5% fee.
PIA counterproposal for all invoicing and payments were to be made in Pakistan rupee, which meant a serious problem and risk for ACI. As the earnings in Pakistan are remitted, they will be converted to dollars. However, because Pakistan's currency favors depreciating against the dollar over time, there will be less dollar earnings received. If ACI borrowed funds from banks in Pakistan, the initial investment would have been smaller. Also, the payments by the subsidiary on loans in Pakistan would cause less remitted earnings over time.
By financing this project with the same currency that is received from the project, ACI can reduce the sensitivity of a foreign project's NPV. The future depreciation of the rupee would hurt ACI since the rupee earnings would be worth less when remitted and converted to dollars. The proposed acquisition is likely to be more feasible if the rupee is expected to appreciate over the long run. For Example, ACI would like to close the deal when the rupee is weak. Only provided that after the purchase, a strengthened rupee will convert the ACI's earnings remitted to the parent into a larger amount of U.S. dollars.
The project is only worthwhile if the return (from an ACI perspective) is sufficiently large so that it exceeds the investment required by ACI.
This transaction presented a series of risks for Avicular Controls - uncertainties about Pakistan as a country risk; a history of payment delays by Pakistan Airlines; potential foreign exchange problems for payment terms, among others. Review the risks for Avicular Controls and its efforts to reduce them in the structure of the transaction.
It was against corporate policy to receive payment in any other currency than U.S. dollars. This specific transaction was already considered a troubled one internally within ACI, because it did not meet corporate goals on return on sales and had been continually postponed. Unfortunately, the division within ACI had already included it in their prospective sales goals for the period, so the pressure was on.
The rupee had suffered near-term devaluation. It had experienced a relatively recent devaluation of 7.86%, which by traditional exchange rate...
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