Auditing: A Risk Based-Approach to Conducting a Quality Audit
10th Edition
ISBN: 9781305080577
Author: Karla M Johnstone, Audrey A. Gramling, Larry E. Rittenberg
Publisher: South-Western College Pub
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- What are the expected spot Canadian/Bruneian exchange rates over the next six years? Is the Canadian dollar expected to
depreciate or appreciate against the Bruneian dollar during this project period? Is this prediction favourable to Blooming Blueberries’ project?
2)What is the
3)What other exchange rate risk exposure should the company consider before investing in the project? Explain these risk exposures to Larry.
4)What other risk factors (besides exchange rate risk) should the company consider before investing in the project? Search The Straits Times (from Singapore) for news on Brunei, and identify one major issue that the company may face, other than exchange rate risk, that could sway Larry one way or the other regarding investing in Brunei.
5-If the company is able to borrow the 1 million Brunei dollars capital from a local bank in Brunei at 10%, will it make a difference whether it borrows the money in Canada or in Brunei? Barry says no, according to the Uncovered Interest Parity and Generalized Fisher Effect relationships between exchange rates and interest rates. Explain why this is so.
6-Based on all the above analyses, should the company invest in this distribution centre in Brunei?
![Case 1: International Capital Budgeting Case
Blooming Blueberries Inc. is a privately owned blueberry production company in Richmond,
BC. The company has been in business since 1984, and is managed by owner-manager Mr.
Larry Daly and his son, Mr. Barry Daly. The company produces blueberries and wholesales
most of its product in Canada. Two years ago (2012), Larry connected with a Bruneian
businessman, who acted as a middleman for Blooming Blueberries, to export and distribute
blueberries in Brunei. The company has been exporting 100,000 pounds of blueberries to
Brunei each year for the past two years. Due to a recently published scientific study that
showed that people who eat at least one pound of blueberries a week live longer and
healthier, the demand for blueberries worldwide is expected to increase dramatically. In
Brunei, demand for the company's blueberries is anticipated to increase to 300,000 pounds
next year, with expected growth of 5% percent per year for the next five years.
Larry is considering building a distribution centre in Brunei to handle the increased demand.
The Bruneian middleman is presently taking a 50% cut on the revenues from the sales of
blueberries in Brunei. By eliminating the middleman, Larry thinks that he will be able to
make a higher profit.
The company recently reached a tentative agreement (called a memorandum of
understanding) with the Brunei government, allowing it to build a facility in Brunei to
receive and distribute its products for the next six years. The plant and equipment will cost
2 million Brunei dollars. Fixed costs are estimated to be 200,000 Brunei dollars per year,
and variable costs (including labour and materials) are estimated to be 1 Brunei dollar per
pound. Shipping of the product will cost about $100,000 Canadian per year. The plant and
equipment can be depreciated over a 10-year period on a straight-line basis. At the end of
the sixth year, the fixed assets can be sold for an estimated $860,000, with any
depreciation recapture taxable at 30%. The corporate tax rate in both countries is 30%. The
project will also require an investment of net working capital of $250,000 Canadian at the
start of the project, which will be recovered at the end of the sixth year. The weighted
average cost of capital for Blooming Blueberries is around 16%. The company can borrow
funds from its bank at an interest rate of 8%.
Barry Daly, Larry's son, has a master's degree in finance from the Canadian Agricultural
University. Barry advised Larry that the changes in the exchange rate may make or break
this project. Larry asked Barry to help find out more about the Canadian-Brunei exchange
rates. Barry knows that the future spot exchange rates between the two countries can be
estimated using the Relative Purchasing Power Parity (RPPP) formula:
E[S] = E[St-1] × [1 + (bc-bRAM+)]
where
E[S] Projected exchange rate at time t
E[St-1] = Projected exchange rate at time t-1, one period before time t
DECA = Projected inflation rate in foreign country at time t
bRom.t Projected domestic inflation rate at time t
Par mamala](https://content.bartleby.com/qna-images/question/5f799239-bf75-4c8c-a88f-30febcc0c4a0/f98742b4-f4b6-44e5-9633-d3b0e5798114/15sk8va_processed.png)
Transcribed Image Text:Case 1: International Capital Budgeting Case
Blooming Blueberries Inc. is a privately owned blueberry production company in Richmond,
BC. The company has been in business since 1984, and is managed by owner-manager Mr.
Larry Daly and his son, Mr. Barry Daly. The company produces blueberries and wholesales
most of its product in Canada. Two years ago (2012), Larry connected with a Bruneian
businessman, who acted as a middleman for Blooming Blueberries, to export and distribute
blueberries in Brunei. The company has been exporting 100,000 pounds of blueberries to
Brunei each year for the past two years. Due to a recently published scientific study that
showed that people who eat at least one pound of blueberries a week live longer and
healthier, the demand for blueberries worldwide is expected to increase dramatically. In
Brunei, demand for the company's blueberries is anticipated to increase to 300,000 pounds
next year, with expected growth of 5% percent per year for the next five years.
Larry is considering building a distribution centre in Brunei to handle the increased demand.
The Bruneian middleman is presently taking a 50% cut on the revenues from the sales of
blueberries in Brunei. By eliminating the middleman, Larry thinks that he will be able to
make a higher profit.
The company recently reached a tentative agreement (called a memorandum of
understanding) with the Brunei government, allowing it to build a facility in Brunei to
receive and distribute its products for the next six years. The plant and equipment will cost
2 million Brunei dollars. Fixed costs are estimated to be 200,000 Brunei dollars per year,
and variable costs (including labour and materials) are estimated to be 1 Brunei dollar per
pound. Shipping of the product will cost about $100,000 Canadian per year. The plant and
equipment can be depreciated over a 10-year period on a straight-line basis. At the end of
the sixth year, the fixed assets can be sold for an estimated $860,000, with any
depreciation recapture taxable at 30%. The corporate tax rate in both countries is 30%. The
project will also require an investment of net working capital of $250,000 Canadian at the
start of the project, which will be recovered at the end of the sixth year. The weighted
average cost of capital for Blooming Blueberries is around 16%. The company can borrow
funds from its bank at an interest rate of 8%.
Barry Daly, Larry's son, has a master's degree in finance from the Canadian Agricultural
University. Barry advised Larry that the changes in the exchange rate may make or break
this project. Larry asked Barry to help find out more about the Canadian-Brunei exchange
rates. Barry knows that the future spot exchange rates between the two countries can be
estimated using the Relative Purchasing Power Parity (RPPP) formula:
E[S] = E[St-1] × [1 + (bc-bRAM+)]
where
E[S] Projected exchange rate at time t
E[St-1] = Projected exchange rate at time t-1, one period before time t
DECA = Projected inflation rate in foreign country at time t
bRom.t Projected domestic inflation rate at time t
Par mamala
![In Year 2, the projected exchange rate from last year, E[S₁] and the foreign and domestic
inflation rates for Year 2 are used to derive the new projected exchange rate for Year 2.
Barry gathered the following information from the Internet:
Current spot rate: $1 Canadian = $1.15 Bruneian
Government of Canada 1-year Treasury Bill rate = 1% per annum (effective)
Estimated Inflation rates:
Year
2015
2016
2017
2018
2019
2020
Canada
1.8%
1.8%
1.7%
1.7%
1.6%
..8%
Brunei
1.0%
1.0%
1.0%
1.0%
0.9%
0.9%
The current wholesale price of blueberries in Brunei is 5 Brunei dollars per pound, and this
price is expected to increase at the same rate as the Bruneian inflation rate. Variable costs
are also expected to increase at the Bruneian inflation rate. Fixed costs and shipping cost
are expected to remain the same for the next six years.
Before deciding whether to Invest In this project, Larry needs answers to the following questions:](https://content.bartleby.com/qna-images/question/5f799239-bf75-4c8c-a88f-30febcc0c4a0/f98742b4-f4b6-44e5-9633-d3b0e5798114/wn2ja9_processed.png)
Transcribed Image Text:In Year 2, the projected exchange rate from last year, E[S₁] and the foreign and domestic
inflation rates for Year 2 are used to derive the new projected exchange rate for Year 2.
Barry gathered the following information from the Internet:
Current spot rate: $1 Canadian = $1.15 Bruneian
Government of Canada 1-year Treasury Bill rate = 1% per annum (effective)
Estimated Inflation rates:
Year
2015
2016
2017
2018
2019
2020
Canada
1.8%
1.8%
1.7%
1.7%
1.6%
..8%
Brunei
1.0%
1.0%
1.0%
1.0%
0.9%
0.9%
The current wholesale price of blueberries in Brunei is 5 Brunei dollars per pound, and this
price is expected to increase at the same rate as the Bruneian inflation rate. Variable costs
are also expected to increase at the Bruneian inflation rate. Fixed costs and shipping cost
are expected to remain the same for the next six years.
Before deciding whether to Invest In this project, Larry needs answers to the following questions:
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