Relation Inflation And Inflation Uncertainty -Myassignmenthelp.Com

Question: Discuss About The Relation Inflation And Inflation Uncertainty? Answer: Introduction This report is about the BigS, a manufacturer of stereos in New Zealand. Most of its main parts that are used for assembling a stereo are imported from Canada. Recently the rate of Zealand dollar is depreciated against the dollar rate of Canada. This depreciation has increased the production cost for the company. In the phase of globalization, BigS is facing a tough competition from foreign companies that are into the same field and running their business in New Zealand. All these circumstances have increased the problems for the BigS organization many times. The revenues of organizations have fallen down to an extent of 15%. Further, the return on investment of the organization has seen an enormous low of 6%. In this report, we will discuss the two other organizations namely Birdies and Placard that whether the BigS organization should invest in Birdies or Placard and what long-term benefits BigS will receive in future after investing in one of these organizations. Birdies are opera ting its business in country A and are enjoying a situation of monopoly in its business they are into the same business of producing or manufacturing stereos, whereas Placard is operating its business in Europe and has yielded an average return on investment of 17% in the last 3years. The Placard is into the business of manufacturing gaming headsets. Diversification Analysis Diversification is a tool or a strategy that is used by big or medium scale business organizations to expand or to bring new technology into the existing business. In this report, we are going to make a diversification analysis of the opportunities and the risk that will come along with this diversification if organization BigS choose to invest in Birdies or Placard. Now if we talk about Birdies then it is very clear that the organization would yield a maximum return on investment of around 9% and that too in 5 years, and this organization is enjoying a monopoly position in its country that means they have no close competition in their line of business and if BigS decides to invest in Birdies then it will directly double the benefits of the BigS organization. Any business organization in this world desires to grow more and more, and diversification is one out of the four strategies to expand the business of a business organization. Below is the table that shows the four strategies of expanding business(Meja 2011) Market Penetration Product Development Market Development Diversification While three of the mentioned strategies are somewhat related to each other, then there is diversification that means entering a business organization into a different market or acquiring a business organization(Bookbinder 2016). Now coming back to the situation, BigS that used to earn a good amount of revenues is now suffering because of the change in the dollars rates of New Zealand and Canada, and because of the international competitors. Now, BigS have two options whether to invest 40% in Birdies or to invest the same amount in Placard. Now we will discuss the opportunities or the risk that would come along with the investment in Birdies(Bogle 2015). Birdies Birdies is also a producer of stereos in country A. Birdies is not operating its business on a large scale like BigS but they are enjoying a monopoly position in this marketing in their country. Country A is imposing high-interest rates in order to curb inflation. If in case BigS go with option A, then it will not really increase benefits of the BigS, as the interest rates are higher, income is low in country A, the expected return on investment that BigS will get is around 7%. There are no chances of any change in the monetary policy in the near future that means BigS have to face the interest rate of 10%. The risks that will come along with this diversification are as under(Kenny 2014): Low income and high rate of interest will worsen the situation at the BigS, as it is already suffering from the increase in operational costs and 15% decrease in the revenues. Birdies are operating their business in a country where income is low which ultimately means they are using poor technology, hence another risk is shifting from high to low technology will again put them into worse condition(Elseiver 2018). Another risk that would entail with this investment is that the foreign competitors will take the show away while BigS will be busy setting up in Country A. Placard Now talking about Placard, it is a business organization that manufactures gaming headsets and is using technology that would prove out to be very new for BigS. Placard and BigS are somehow into a related business. Now if BigS decides to invest in Placard which only conducts its business in Europe then it will prove out to be very profitable for BigS as the interest rates that Placard is currently imposed is only 0.5%, it may be reverted to its previous state if the inflation goes beyond the level of 1%. The Placard is using high technology and if BigS decides to take over its business then BigS may experience an increase of 7% on the return on investment. Placard case is riskier than that of Birdies. However, the risks include are, as under: Placard business has high risk i.e. 13% standard deviation. Interest rates may get an increase in Europe. Competition is very extreme in their market, BigS may or may not be able to handle. Change in Inflation, Interest Rate, and Exchange Rate Investment in Birdies If BigS makes an investment in Birdies, then the change in the inflation rate, interest rate, and exchange rates would have the following effects on the investment: If there is an increase in the inflation rate in country A, where birdies are operating its business then it will directly increase the interest rate, which will result in lower revenues and higher interests for BigS. Suppose if the exchange rates fall then it will make the things cheaper in country A that means BigS will have access to cheaper resources but it also means that they will earn a low income. Investment in Placard If BigS makes an investment in Placard, then following will be the results of the changes in inflation, interest and exchange rate: If there is an increase or decrease in the inflation rate, then it will not harm the revenue of BigS in Europe is comparatively lower than that of Country A. Exchange rates would affect the BigS organization, the currency of Europe is a pound and BigS deals in dollars, so BigS will have to bring more capital if the exchange rate increases. Interest rates are as low as 0.5% in Placard country, so little change whether increases or decrease will not going to harm BigS. Two Scenarios Pessimistic and Optimistic Optimistic Birdies Birdies is a business organization operating its business in country A. Birdies is enjoying a position of monopoly in their country and have an access to cheap labor. Below are given the results according to the Optimistic view, if BigS makes an investment in Birdies: The operational cost of BigS will be reduced to a great extent as the labor cost in country A is comparatively cheaper. BigS will be enjoying double benefits as they will be able to shift resources (labor, machinery) from country A to their original country i.e. New Zealand. The income of BigS will be doubled or maybe tripled, in case of rising in the prices of oil, as the economy of a country is dependent mainly on the global prices of its commodity. Pessimistic Birdies Now if we take up a pessimistic view and then the results would be as under: Due to higher interest rates and inflation rate, revenues are going down to an unbelievable low. A decrease in the oil prices will further decrease the income level in the country, which means that BigS will have low income. Cheap labor means less productive and less trained labor that will again result in the loss of BigS. Optimistic Placard The Placard is a manufacturer of gaming headset in Europe. The competition in their field is very aggressive; however, they have a good technology. In addition to this, the interest and inflation rates are very low in the country that Placard is operating its business in. Below will the optimistic scenario: Lower interest and inflation rates will let BigS earn a good income, as lower interest and inflation rate will be an opportunity to earn more. High technology will allow BigS to produce high tech stereos on their own price. Labor in Europe will be trained and highly productive, this will further reduce the operational cost and increase the revenues of the BigS. Pessimistic Placard The Pessimistic scenario will produce the following results: The political uncertainty in Europe can bring the country on its knees, which will result in recession or inflation, which means that BigS will face loss. Fierce competition is faced by Placard, which ultimately means that the first step would be to take care of the competition. The severe risk may totally put an end on the revenue of the BigS, as Placard is not only facing the risk of competition but also the risk of increased inflation or interest rates and the risk of the political uncertainty. Financial Derivatives In this section, we are going to discuss the risks to which BigS would be exposed if they decide to expand their business with either Birdie's or with Placard. The risks that the organization BigS would be exposed to are as under: In case, BigS decides to expand its business by investing in Placard, a European gaming headset manufacturer then the first or the major risk that will come into the way of BigS is the risk of the political uncertainty. Political instability effects the investment in an adverse manner(Ababa 2014). Suppose the current governments implies 2% tax on the income of the business and a new government come into power and increase this tax by 8% then this will directly harm the revenues of the business. Now if BigS decides to make an investment in Birdies then again the risk of earning low income will come in the way of BigS. Country A where birdies are operating its business is a low-income country which means that even if BigS successfully earn money from birdies then also their revenues will remain low. The High rate of interest and inflation in country A is another risk to the revenues of the BigS. There is no point of operating a business in a country where the interest and inflation rates are high. More the inflation in a country less will be the spending power of a consumer of that country(Sylla 2015). Fierce competition in Europe is faced by Placard, now if BigS makes an investment in Placard then not only the risk of change in interest rates, exchange rates or political uncertainty but the fierce competition will affect the investment of the BigS(Pillow 2013). BigS if decide to make an investment if any of the mentioned business organization then to cover these risks mentioned above, BigS can make a contract (Financial Derivative) with either of the firm and then this contract can be used as a hedge against the risks that BigS is exposed to(Gupta 2015). The contract can contain the following conditions(Vashishtha 2010): Commodity Risk: In this type of financial derivative, the supplier and the buyer comes into a contract in present for a future date that if in case the price of a commodity or a raw material increases then the supplier will supply that commodity on the present rate and not on the increased rate. This can be used for the case of Birdies and Placard both(Vahey 2014). Interest Risk: If in a case due to political uncertainty the change in interest makes the company unable to pay the interest then this financial derivative can be used as a hedge against this risk(EduPristine 2015). Recommendations In this section, few recommendations are provided for BigS to follow for the investment purpose. BigS should invest in Placard as BigS is in more need of technological change rather than earning revenues. Once BigS gets its hands on new technology they can manufacture different stereos that will allow them to charge prices more than what they were charging till date. Moreover, BigS is and Placard are almost into the same business the only difference is one is producing the stereos while the other is producing the gaming headsets both are related to the sound. Another benefit that could be enjoyed by BigS is the lower rate of inflation and interest in the UK. Less inflation means more spending power and low-interest rates mean more income(Daniela Viorica 2014), if we consider all these points with that of Birdies then Birdies stands nowhere close to the investment proposal of Placard. There is no doubt that investment in Placard is riskier but that is also true that more the risk the better will be the outcome(Vukovic 2016). So BigS is recommended to invest in Placard rather than going for Birdies. References Ababa, DA 2014, Impact of Political Instability, 5th edn, Marletto Publishers. 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