Farah Jeans of San Antonio, Texas, is completing a new assembly plant near Guatemala City. A final construction payment of Q8,400,000 is due in six months. (“Q” is the symbol for Guatemalan quetzals.) Farah uses 20 precent per annum as its weighted average cost of capital. Today’s foreign exchange and interest rate quotations are as follows:
Construction payment due in six months (A/P, qutezals) 8,400,000
Present spot rate (quetzals/$) 7.0000
Six-month forward rate (quetzals/$) 7.1000
Guatemalan quetzal six-month interest rate (per annum) 14.000%
U.S. dollar six-month interest rate (per annum) 6.000%
Farah’s weighted average cost of capital (WACC) 20.000%
Farah’s treasury manager, concerned about the Guatemalan economy, wonders if Farah should be hedging its foreign exchange risk. The manager’s own forecast is as follows:
Highest expected rate 8.0000
Expected rate 7.3000
Lowest expected rate 6.4000
What realistic alternatives are available to Farah for making payment? Which method would you select? Give reasons for your answer. (5.2)
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