Herewego Travel specializes in offering custom-built tours in Britain and in Scotland. It commenced its business in 2003 and is able to increase its business over the years. In 2009, Herewego Travel is having good bookings thanks to the Homecoming year declared by the Scottish government and due to the devaluation of British pounds. Devaluation actually will help Herewego Travel to increase its profitability and at the same time, it also poses risks due to exchange rate fluctuations. Any upward movement in the exchange rate will have a drastic impact on the company’s profitability since its entire revenue comprising of US dollars and other foreign currency payments. Hence, it is inevitable for the company either to hedge its forex risks or to avail forward contract to mitigate the financial losses due to forex exposures. Since Herewego has a very good booking for the year 2009, it is estimated to have good business in the year 2010 and 2011 also. Accordingly, projections have been made so that Herewego is able to maintain 65% of net margin in the years 2009, 2011, and 2012. Various assumptions have been made and the same has been listed hereunder for arriving at the above projection. A trend linear program chart has also been prepared for the analysis of projected revenues and expenses in the excel sheet enclosed. Thus, I wish to recommend Mr. Kelvin, the owner of Herewego Travel to cover adequately his forex risks and to buy the vehicle for company purposes rather than going for leasing the same as it will reduce the profits over the year to some extent as detailed in the excel worksheet attached.
Introduction
Here we go travel is a specialized tour operator in the UK. It offers sightseeing in UK and Ireland to unusual and interesting places. From April to October, the main travel season starts and during the winter period, there will be only very rare trips. Kevin has three very experienced tour guide drivers and also is owning three vehicles now. Kevin also acts as a tour guide driver when there is a need. He also employs an office staff. He plans to add another vehicle at the cost of £ 20000. Depreciation on these vehicles has been provided on a straight line basis. Due to five star service offered by Herewego, bookings for summer 2009 are robust. Mr. Kevin is the owner of the Herewego and anticipates that business in 2009 will be as per his forecast He plans to spend more on marketing costs and is anticipating that office and another cost will swell by fifty percent in 2010. Since Kevin receives a net £400 per day and foreign agent who charges £100 extra per passenger will not be considered in the accounts Kevin. Since Kevin Income is totally based on foreign exchange, it is wise to go for hedging or book a forward contract to cover any fluctuation loss in forex. This essay forecasts the sales trend of Here we go for the years 2009, 2010, and 2011.
Assumptions
The Following Assumptions have been made:
- Tour group consists of less than six people and the length of each tour is 4 days.
- Main travel season is from April to October and with occasional trips in the winter.
- It presently operates 3 vehicles and 3 experienced tour guide drivers and the owner Kelvin is four and one administrative employee.
- There is no work for drivers from November to February.
- No hotel stay or food expenses are borne by the Here we go.
- Average price is charged is 400 pounds per day with 12 hrs driving.
- Driver’s salary is 150 pounds while working.
- Including estimates, for 2009, 705 bookings have been given. As each tour will take about 4 days, total booking is multiplied by four days and then by 400 Pounds to arrive at revenue for Here we go.
- Administrative staff salary has been taken into consideration.
- Marketing expenses have been increased for the years 2010 and 2011 considering the volume involved.
- Mr. Kelvin’s personal expenditure, expenses incurred to attract customers have not been considered.
- Commission taken by foreign tour operators has not been taken into considerations.
- New vehicle depreciation has been spread for five years with £ 4000 to be written down.
- Old Vehicle depreciation has been exhausted after the provision made for the year 2009.
Forecasting the sales and profitability by using the time series.
The majority of the business is forecasting their profitability and sales on the footage of their past turnover or sales. In this case, the sales are seasonal in nature and also are affected by the economic condition especially in the case when there is a recession. Further, in the Herewego case, the bookings are strong during 2009 thanks to the devalued pounds and the Scottish government announcement of the homecoming year.
Employing time series analysis to organize an efficient sales forecast needs Herewego to:
By employing a moving average, Herewego has to smooth out the erratic factors.
Here we go has to fine-tune for seasonal –variation.
To recognize and evaluate the impact of particular marketing responses.
Leasing or Owning a Vessel – Decision.
- Internal Rate of Return is 13%
The Internal Rate of Return is pertaining to the evaluation of the time value of money. This calculation and approach are slightly different from the NPV method of calculation. The IRR on an investment is the discount rate that offers the present value of cash flows that emanate in the future which equals zero. Thus, IRR is to employ a discount rate that will make the cash outflow equal to the cash inflows. Thus, the discount rate has to be found by a trial and error method.
The discount rate that makes the future net cash inflows is equal to zero which is the internal rate of return on the investment. If IRR exceeds one’s target rate, then one can say yes to such investment. IRR is the rate of return that investment itself generates. In IRR calculation, the investment has only three ingredients namely the cash inflows, the cash outflow, and the number of years. (Gorman 2003:207).
As Herewego is having an IRR of 13%, it is wise to go for purchasing the own vehicle instead of leasing.
- Net Present Value £874.26
Under NPV, one can calculate all NPV of all the future cash outflows, the money one will invest and cash outflows, the money the investment will generate. When outflows are being subtracted from inflows, it gives net balances. In case, if the net amount is positive, then the discounted cash flows outweigh the outflows and hence the NPV is positive, and in such cases, investment can be considered as worth. The net present value future cash flows from the project after deduction of £ 20000 which is the initial investment is £874.26and since it is a positive figure, NPV for the project can be considered as a viable option for the investment.
- Profitability Index 1.05
The Profitability Index is one of the dependable strategies for appraising a project. When a financial analyst wants to do a large deal of calculation to find out how many years it will take the initial outlay to recoup in a speedy manner. The PI method compares the present value of future cash inflows of a project to its initial investment by means of a simple yardstick. In case, if the PI is less than 1, then it is wise not to peruse the concerned project. A financial analyst should be more vigilant in selecting the discount rate that is most opts for assessing a project. (Groppelli, Nikbakht 2000:159). As Herewego is having more than 1 PI, it is wise to go for owning a vehicle rather than leasing it.
- Payback Period 2.29 years
This method is easy to use and easy to understand. The payback period strategy is commonly employed to evaluate how long it will take before the initial investment or original capital is able to be recovered. However, it does take into account the value of time and does not serve as a gauging of profitability. This method does not consider cash inflows generated after the initial investment has been recouped.
As per plan V in the IRR, NPV worksheet, total expenses to be incurred for leasing a vehicle during peak season period works out to £ 14,250 whereas the cost of a new vehicle is only £20000. Hence, I strongly advise it is better to go for the purchase of a new own vehicle as IRR, NPV, PI, and Payback are more attractive than leasing a vehicle during the peak seasons as it improves the profitability of the Herewego.
Foreign Currency Exposure
Herewego is a travel agency engaged in organized tours in UK and Ireland. It attracts a large volume of foreign tourists into the UK. Hence, it will be having earnings through various currencies especially US Dollar.
Thus, a movement in foreign exchange rates may result in either a real or nominal impact on its performance either beneficially or adversely.
Foreign currency exposure can be explained as business sensitivity to change in currency value. Thus, foreign currency exposure may not only have an impact on its financial statements but also on the tourist inflow. It is to be noted that these effects are not qualifiable but quantifiable. Since Herewego 100% revenue comprises fees payable by foreign tourists, its profitability will be affected or correlated in the movement of exchange rates between US dollars and British Pounds.
Accounting exposure is the risk of foreign exchange rate movements affecting the present period financial statements of Herewego It concerns the current period liabilities, assets, expenses, and revenues.
Dollar vs Pounds Movements Forecast
As of 23rd July 2009, today’s conversion rate is 1 £= $1.65,
Suppose, if Herewego is having receivable as of today $ 100,000, it will receive the same in British pounds 60,606. It is to be noted that the above forecast has taken into account the future inflationary trends also.
Moreover, if the rates go up to $1.51 as forecasted in January 2010, it will receive £ 66,225. Hence, as of today, Herewego loses about £ 6019.
Hence, I suggest that Herewego should hedge its forex exposures or take the forward contract to mitigate the losses due to fluctuations in Forex movements.
Conclusion
Hence, I recommend Kelvin to go for the purchase of a new own vehicle as IRR, NPV, PI, and Payback is more attractive than leasing a vehicle during the peak seasons as it improves the profitability of the Herewego. Since Herewego 100% revenue comprises fees payable by foreign tourists, its profitability will be affected or correlated in the movement of exchange rates between US dollars and British Pounds. Since Kevin Income is totally based on foreign exchange, it is wise to go for hedging or book a forward contract to cover any future fluctuation loss in forex.
References
- Gorman Tom. (2003). The Complete Idiot’s Guide to MBA Basics. New York: Alpha Books.
- Groppelli Angelico, A & Nikbakht Ehsan. (2000). Finance. New York: Barron’s Educational Series.
- Shoup Gary. (1998). The International Guide to Foreign Currency Management. New York: Lessons Professional Publishing.