Question Tag: Interest Rate Calculation

a) Jeanne Cosmetics Ltd is located in Taifa and is now considered as the leader of organic and natural cosmetic products in the municipality. Per the cash management policy of Jeanne Cosmetics Ltd, any excess cash that is idle for more than three months should be invested. Three months ago, the company invested GH¢100,000 of idle cash in a 3-month fixed deposit account. The investment matures today, and the company will receive a maturity value of GH¢105,000.

Required:
i) Compute the interest rate earned on the account over the investment holding period. (2 marks)
ii) Suppose the interest rate on the account remains the same, and the company rolls over the principal, compute the annual simple interest rate on the investment. (2 marks)
iii) Suppose the interest rate on the account remains the same and the company rolls over both the principal and interests, compute the annual compound interest rate on the investment. (2 marks)

b) Apphia Fabrics Ltd plans to replace its existing manufacturing plant with a newer version in three years’ time. The replacement cost of the existing plant is GH¢10 million currently. However, experts forecast that the cost of the newer version of the plant will be GH¢12 million in three years’ time.

On the advice of the Finance Manager, the company will start saving from now to raise the required amount to buy the plant in three years’ time. Consequently, the company has signed an investment agreement with DT Financial Services Ltd. Per the agreement, the company will deposit equal amounts into an interest-bearing account at the beginning of each of the next three years. The annual nominal interest rate on the account is 16%, but interest will be compounded monthly.

Required:
Compute the equal annual deposit required to raise the required amount in three years’ time. (4 marks)

c) Aduro Pharmaceuticals Plc is a Ghana-based multinational company with a production facility in India and marketing subsidiaries in some West African countries. The Treasury Department of the company is considering strategies for managing its foreign exchange risk exposures. In particular, the Treasury Department is concerned about the following two cases of foreign exchange risk exposures:

Case 1:
The exchange rate between the Ghanaian cedi (GH¢) and the British pound sterling (GBP) is currently GH¢8.1125/GBP1. The company recently borrowed GBP500,000 from an offshore bank to buy active chemicals for the production of paracetamol syrup. The loan is to be paid in six months’ time. Market pundits project that the Ghanaian cedi would depreciate against the pound sterling over the next six months.

Case 2:
The exchange rate between the Ghanaian cedi (GH¢) and the Indian rupee (INR) is currently GH¢0.0799/INR1. The company’s production subsidiary in India presents its financial statements in the Indian rupee. The net worth of this production subsidiary in India is INR20 million. The company would be preparing its consolidated financial statements in a few months’ time. Market pundits project that the Ghanaian cedi will appreciate against the Indian rupee.

Required:
i) For each case, identify the type of currency risk exposure the company is facing. (2 marks)
ii) In respect of Case 1, recommend TWO (2) internal strategies and TWO (2) external hedging strategies the Treasury Department can use to manage the foreign exchange risk exposure. (8 marks)