Assignment

Oman Batteries SAOG

Oman Batteries SAOG, a fast growing company is planning to expand its operations by selling its car batteries in Africa.

The current price of its fastest selling car battery is 15 Rials and it plans to sell the product initially in Egypt. Expected sales in Egypt in the first five years are as follows: 50,000 units in the first year, increasing by 10% each year in year two and three, and 15% each year in year four and five.

An important input in production of batteries is metal which is produced in abundance in Africa and which the company is currently importing through suppliers in Egypt. Oman Batteries has estimated that for every battery it requires 75 EGP (Egyptian Pounds ) worth of metal.

The company is considering two alternate production plans:

Production Plan I: Establish a new factory in Egypt at an estimated cost of 15 million EGP. The capacity of the plant would be sufficient to meet the demand for batteries in the next five years. The sale price per battery would be 225 EGP and EBIT as % of Sales is expected to be 40%.

Oman Batteries expects that at the end of five years it can sell the factory at 25% of its current estimated cost.

Production Plan 2: Establish a new factory in Oman to meet the Egyptian demand at an estimated cost of 1 million Rials. The export price per battery would be 15 Rials per battery. EBIT as % of sales is expected to be 30%. Oman Batteries expects that at the end of five years it can sell the factory at 25% of its current estimated cost.
Financing:

Given its current debt equity ratio, Oman Batteries feels that it can easily get a loan for the full amount required for the new factory.

For the purpose of financing the new factory, Oman batteries has two choices:

1. Omani Rial loan for 5 years on floating rate basis.

2. Loan from Euro Credit market in GBP on a floating rate basis: LIBOR 4- 3%

The finance manager is worried about the exchange rate and interest rate volatility. To forecast the future direction of interest rates and exchange rates, the finance manager decided to first collect information about the behaviour of relevant interest rates and exchange rates over the last five years. Future interest rates and exchange rates may follow the same pattern as last five years or may be better ( by 25%) or worse (by 25%)

Information related to past Omani Rial Lending rates is published by Central Bank of Oman in its Annual Report in the table titled "Weighted Average Interest Rates" (chapter on Money and Banking).

Assume no taxes and no inflation.

Required:

- Generate four scenarios which company may be facing. ( Each scenario should specify the expected behaviour of interest rates and exchange rates over the next five years). (Please provide graphs showing the interest rate and exchange rate behaviour over the next five years)

- Calculate the impact on annual profits (in OMR) of the new proposal under each scenario ( You may make additional assumptions if necessary, but these should be clearly stated)

- Recommend your choice. Give reasons and explain