Financial Risk and Portfolio Optimization †MyAssignmenthelp.com

Question: Discuss about the Financial Risk and Portfolio Optimization. Answer: Introduction: Jaguar and Ford mainly fall under automobile industry and are considered competitors of each other. Hence, the acquisition of Jaguar could create the highest value for Ford, which might help the company increasing value. In addition, the values will only be created with the help of synergies that will be created by the company with the acquisition process. This acquisition process might mainly help in generating the levels of synergies in production, and revenue stream that could create value for Ford. Moreover, the combination of Jaguar and Ford could allow both companies to combine their production and dealership. This could help in generating high level of return from investment. In this context, Aliu, Pavelkova and Dehning (2017) stated that companies with the help of acquisitions and mergers can create value by combining their operations and increase the overall profitability. In addition, the value will be created by combing the production system of both the companies and reduce the actual cost of production. This value creation might help the company in declining the costs and increasing the level of returns. Therefore, the combined valuation of the company could help in generating the level of returns from investment. Furthermore, the combination could help in generating high level of sales for the company, as the combined dealership would increase the sales of the firm, while reducing the actual cost of production. This combined valuation would allow both the companies to generate high level of synergies and valuation for investment. Beshears et al. (2016) argued that without the identification of synergies companies are not able to create the relevant value, which might reduce financial stability of the combined company. Calculating share price of Jaguar suing DCF method: Period 1 2 3 4 5 6 Particulars 1990 1991 1992 1993 1994 1995 Turnover (in millions): United States - in $ $850.00 $1,076.90 $1,364.30 $1,728.40 $2,189.70 $2,774.20 Exchange Rate $/ 1.615 1.615 1.615 1.615 1.615 1.615 United States - in 526.32 666.81 844.77 1,070.22 1,355.85 1,717.77 Europe - in DM 434 572.7 755.6 997.1 1315.6 1735.9 Exchange Rate DM/ 3.022 3.022 3.022 3.022 3.022 3.022 Europe - in 143.61 189.51 250.03 329.95 435.34 574.42 Total Turnover in US Europe 669.93 856.32 1,094.80 1,400.16 1,791.19 2,292.19 United Kingdom 324.00 404.80 505.80 632.10 789.80 986.80 Rest of World 172.80 241.30 337.00 470.60 657.20 917.80 Total Turnover - in 1,166.73 1,502.42 1,937.60 2,502.86 3,238.19 4,196.79 Cost of Sales -1,045.00 -1,350.40 -1,730.90 -2,222.10 -2,829.50 -3,608.80 Gross Profit 121.73 152.02 206.70 280.76 408.69 587.99 Distribution, Administration and RD Costs -122.00 -147.30 -177.90 -214.80 -259.40 -313.20 Net Operating Profit -0.27 4.72 28.80 65.96 149.29 274.79 Increase in Net Working Capital -113.2 -34.5 -45.1 -59 -77.3 -101.5 Free Cash Flow -113.47 -29.78 -16.30 6.96 71.99 173.29 Discount Rate 6.72% 6.72% 6.72% 6.72% 6.72% 6.72% Discounted FCF -106.33 -26.15 -13.41 5.37 52.01 117.31 Total of Discounted FCFs 28.80 Particulars Value Value of Company after 1995 2,579.13 PV of Value after 1995 1,745.91 Total Fair Value 1,774.72 Nos. of Shares 182.926 Fair Value per Shares (in ) 9.70 Evaluating prices of Jaguar under different scenarios: Particulars Value Value of Company after 1995 2,445.38 PV of Value after 1995 1,655.37 Total Fair Value 1,659.37 Nos. of Shares 182.926 Fair Value per Shares (in ) 9.07 Increase in DM interest rate by 25%: Particulars Value Value of Company after 1995 2,644.64 PV of Value after 1995 1,790.26 Total Fair Value 1,830.28 Nos. of Shares 182.926 Fair Value per Shares (in ) 10.01 Increase in Yen interest rate by 25%: Particulars Value Value of Company after 1995 2,579.13 PV of Value after 1995 1,745.91 Total Fair Value 1,774.72 Nos. of Shares 182.926 Fair Value per Shares (in ) 9.70 Decrease in $ interest rate by 10%: Particulars Value Value of Company after 1995 3,133.60 PV of Value after 1995 2,121.26 Total Fair Value 2,252.88 Nos. of Shares 182.926 Fair Value per Shares (in ) 12.32 Decrease in DM interest rate by 10%: Particulars Value Value of Company after 1995 2,847.98 PV of Value after 1995 1,927.91 Total Fair Value 2,002.77 Nos. of Shares 182.926 Fair Value per Shares (in ) 10.95 Decrease in Yen interest rate by 10%: Particulars Value Value of Company after 1995 2,579.13 PV of Value after 1995 1,745.91 Total Fair Value 1,774.72 Nos. of Shares 182.926 Fair Value per Shares (in ) 9.70 Depicting the currency Jaguar should manage more: From the overall evaluation of above tables relevant exposure of Jaguar can be calculated, which might hamper their actual revenue from currency conversion. The maximum of revenue that is generated by Jaguar is from US, which relevantly indicates the exposure of dollar, which needs to be managed by the company. In addition, the evaluation of above figure mainly helps in detecting the overall percentage sales, which is conducted in US by Jaguar. The evaluation indicates that maximum of the sales are mainly on US dollar, which states the Jaguar should manage the US Dollar adequately for reducing any kind of losses, which might incur from currency exchange. The US sales Vs worldwide sales depict a relevant sales percentage to 41%, which indicates that maximum revenue is generated from sales in US. Hence, the organisation needs to manage US dollar for curbing the loses, which might incur from the exchange rate (Bruni et al. 2015). The above figure relevantly depicts the overall financial data of Jaguar, which could help in generating the level of return from investment. The major revenue is generated from US, which can be seen from above figure. In addition, the financial performance is dependent on the revenue that is generated in dollars and needs to be converted in pound for increasing the level of returns from investment. Furthermore, without the conversion of sales in pound the actual revenue that is generated by the company is not evaluated. Hence, the risk exposure of Jaguar is immense in terms of dollar revenue. Any decline in the currency value might hamper actual valuation of the stock and directly affect its revenue generating capacity. Therefore, Jaguar needs to conduct adequate valuation and adjust for their exposure in the market, which could help in reducing the losses from currency conversion (Hung et al. 2018). Stating how much should jaguar hedge, while describing financial and industrial hedging: Particulars 1990 1991 1992 1993 1994 1995 United States - in 45.11% 44.38% 43.60% 42.76% 41.87% 40.93% Europe - in 12.31% 12.61% 12.90% 13.18% 13.44% 13.69% United Kingdom 27.77% 26.94% 26.10% 25.26% 24.39% 23.51% Rest of World 14.81% 16.06% 17.39% 18.80% 20.30% 21.87% From the overall evaluation sales percentage that is generated from US is the highest, which might affect the total revenues of the company. In addition, Jaguar needs to hedge its exposure in US for curbing the losses that might incur from volatile currency market. The combined Europe sales are not close to the revenue that is generated from US sales. Jaguar needs to use hedging instruments such as forwards and future contracts for curbing the losses that might incur from currency conversion. The 40% of total revenue that is generated from Jaguar needs to be hedged for shortening the losses in currency conversation. The use of future contacts can reduce the relevant losses from operations. In addition, this derivatives contract might allow the company to hedge its exposure in the currency market and reduce any kind of expected losses, which might incur from currency market (Pfaff 2016). Therefore, buying future contracts of dollar might help in reducing the losses from currency conve rsion for Jaguar. The current exposure of Jaguar in Japan is relatively lower than other countries, where operations of the company has not been conducted adequately. In addition, the revenue generated from japan is relevant low, which reduced the implication and exposure of Jaguar in Yen. This relevant exposure of the company might directly affect the overall profitability, which might incur from operations. This exposure from currency conversion is relatively low, where the actual revenue that is generated in Japan can be hedged with using appropriate instrument (Zhang, Liu and Xu 2014). Stating which exchange rate is Jaguar exposed: In perspective of Ford a US-based shareholder Jaguar is mainly exposed to DM and Pound currency, which could hamper relevant profits of the shareholders. In addition, the major exposure of the company is mainly on pound, where the actual expenses are been conducted for the production of cars. This exposure of the Jaguar after the acquisition might be controlled with the help of hedging process, which might be useful for US-based shareholder to increase their return from investment. Being a US-based shareholder the relevant revenues that is been generated outside US needs to be hedged for reducing the negative impact from currency conversion. In addition, the operations of Jaguar need to be evaluated based on US dollars, which might help in generating high rate of return from investment (Damodaran 2016). There are two different sources of each exposure, which is generated from pound and DM. The high-end exposure for US-Based shareholders can be conducted by hedging adequate pound in comparison to dollar. In addition, the exposure from pound is due to the production facility, which is located in UK. In addition, the sales revenue from Europe and Germany is also conducted by the company over the period. Therefore, the revenues and expenses incurred in UK is the major source of exposure for the pound currency. The second source of exposure is the currency DM, which is generated from Germany. Jaguar conducts adequate sales in Germany, which could increase the accumulation of DM by the company and needs to be converted in US dollar. Moreover, this source of exposure is relevantly high, as the company obtains adequate revenue from the sales of cars in Germany, as depicted in case study (Fracassi 2016). Stating which exposure should Ford care about: From the overall evaluation, exposure in pound needs to be assessed by Ford and can take relevant measure to control risk from currency exchange. In addition, Ford after acquiring Jaguar needs to be concerned regarding exposure in pound that is made by the company. Hence, the exposure in pound is the main concern for the company, as the overall revenue and expense are in pound. This would directly hamper the actual performance of the company if Ford is not careful in hedging their exposure in the UK market. Furthermore, the exposure on DM also needs to be evaluated by Ford, as adequate revenue is generated from Europe division of Jaguar (Foley and Manova 2015). Therefore, exposure in currency market and commodity market needs to be conducted by Ford for reducing the risk from their investment. From the overall evaluation, Jaguar has relevant exposure in pound and DM, which needs to be hedged adequately for reducing risk from currency market. In addition, the exposure in the current market mainly needs to be reduced by using adequate level of hedging contracts such as futures and forward contracts. In this context, Scholes (2015) mentioned that companies with the help of hedging process can reduce the risk from volatile markets in which they are trading. Furthermore, the evaluation mainly helps in depicting the risk, which mouth hamper the actual profits of the organisation. On the other hand, Bazdresch, Kahn and Whited (2017) criticises that hedging process without evaluation does not provide adequate return for the organisation, while increase the chance of risk from investment. Therefore, Ford needs to have adequate hedging contract for both pound and DM, which could help in generating high level of returns from investment. 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