Hydro Aluminum Consolidated HAC FINA 7360 Dr R

Hydro Aluminum Consolidated (HAC) FINA 7360 Dr. R. Susmel Presented by: Natalia Mora Aamir Nomani

Case Information ¡ ¡ HAC, engaged in production & distribution of Aluminum CVRD (Companhia Vale do Rio Dolce) l Alunorte, sub-division (Aluminum)

Objectives ¡ ¡ Determine the investment opportunity with CVRD Determine under what terms and conditions should HAC accept CVRD’s offer

Country Report - Brazil ¡ Checklist method l Risk is assessed based on: Economic Indicators, to evaluate the country’s financial condition ¡ Debt Management, to measure the country’s ability to repay debt ¡ Political factors, to evaluate political characteristics and political stability ¡ Structural factors, to measure socioeconomic conditions ¡

Ratings Table Conversion Table of a Country's Grade into a Rating Overall grade Rating 91 -100 AAA 81 -90 AA 71 -80 A 61 -70 BBB 51 -60 BB 41 -50 B 31 -40 CCC 21 -30 CC 11 -20 C 0 -10 D Rating Excellent Average Risk Low Quality Excessive risk

Brazil Risk Analysis Short-term horizon Factor Long-term Horizon Weights Weighted Grade Factor Weights Weighted Grade Economic 0. 3 50 15 Economic 0. 3 45 13. 5 Debt Management 0. 3 60 18 Debt Management 0. 3 65 19. 5 Political 0. 2 66 13. 2 Political 0. 2 79 15. 8 Structural 0. 2 65 13 Structural 0. 2 60 12 Total 59. 2 = BB Total 60. 8 = BB

Calculating βi ¡ βi. W = βi * βcw βi = Domestic beta for Alcan and Alcoa l Βiw = Sensitivity of the assets to the world market l βcw = Sensitivity of the domestic market to the world market Domestic Markets: S&P and BVSPA World Market: MSCI World Index l

Calculating project’s Beta

FEASIBILITY DATA ¡ 1999 USD/BRR 1. 2105 ¡ Costs: USD 160 M, USD 22. 85/year ¡ Tax rate: 8. 78% (From CVRD 98 financial statements) ¡ Long-term Gov. Securities 98: 18. 06%

NPV CALCULATION Discount rate = Long-term Brazilian securities rate + 2. 75% (given) ¡ NPV of the project = $7. 23 M ¡ Since NPV = +ve, we advice HAC to invest ¡

FUNDING POLICY ¡ ¡ ¡ HAC should borrow as much funds as it can in Brazil to cover the economic exposure. Debt payments should match with revenues. Better balance between inflows and outflows denominated in foreign currency (BRR). Borrow from Brazil’s Government in BRR. Finance from investors and suppliers in BRR.

HEDGING POLICY i) 5% deposit of the proposed investment: Buy forward BRR for paying the deposit. If we know when CVRD is giving us the money back in case of loosing the contract buy a BRR put option for that time T. ii) In case HAC's bid is accepted it needs to make a substantial investment in BRR denominated assets: For the net revenue amount after paying debt denominated in BRR. Sell 7 -year BRR forward and Roll it over, or sell BRR forward today for each of the revenues from 99 to 05.

OPTION’S VALUE The Option: Convert credit to equity by acquiring CVRD’s common shares at a discount of 30% from the price. CVRD's Infromation EPS 1998 Stock price Dec 98 Stock's SD BRR USD 2. 67 3. 23 9. 32 11. 2 0. 815

TO FIND THE STRIKE PRICE

OPTION’S VALUE 1) d 1 P ’ 05 = P/E ratio * EPS d 2 ’ 05 0. 07 -2. 09 N(d 1) N(d 2) 0. 02 C(BRR) 3. 41 C(USD) Strike Price using 1 USD 165. 4 Strike Price for HAC USD 115. 8 Strike Price using 2 USD 102. 2 Strike Price for HAC 0. 53 1. 36 2) d 1 0. 29 d 2 -1. 86 N(d 1) 0. 62 N(d 2) USD 71. 6 0. 03 C(BRR) 4. 16 C(USD) 1. 66