Great Eastern Toys (A)

This is a series of four case studies illustrating a number of key financial issues facing many small to medium sized companies. The setting is Hong Kong, but the concerns of the company’s management are universal: financing growth, measuring performance, deciding whether or not to invest in a new product, valuation of the company for a possible sale, dealing with currency risk. Company Situation In late July 1998, the senior management of Great Eastern Toys, a medium-sized, family-owned company with annual sales of over HK$245 millions (US$31 million) from designing and distributing children’s toys, books, and games was reviewing recent performance and future operations. The company exported about 50% of its products to North American markets, close to 50% to major department stores and distributors in Europe, and less than 5% in the local market. Its principal suppliers were in Hong Kong; it financed its operations mainly with the local currency, Hong Kong dollars, but also with Yen loans. Great Eastern Toys (A) The company had enjoyed substantial growth following management changes in 1996, Management’s attention had been focused on expanding sales, leading them to ignore a large increase in working capital needs. These had been financed mainly with short term bank borrowing. The economic crisis in Hong Kong in 1998 led the company’s banks to ask that loans be substantially reduced with potentially serious liquidity consequences for the firm. The “A” case focuses on how to deal with these developments. Students are asked to evaluate the company’s situation using standard tools of financial analysis: ratio, cash flow, and profitability analysis. Two class sessions are normally needed for adequate discussion of the various issues arising in the case.

The case raises many of the typical issues facing exporters, importers, and others active in international trade. These include: 1. Should companies hedge currency or other financial risks? Should companies speculate - that is, try to make money from taking currency positions? 2. How does one measure what is at risk? 3. If there really is a risk of loss from fluctuating currencies, what can be done about it? 4. What instruments are appropriate to manage this risk? 5. How do the foreign exchange markets function, and what is their relation to the financial markets? 6. Can currency movements be forecast? If so, how does one go about it? There is adequate information in the case study to explore all of these questions. However, the instructor will need to explain a number of technical issues such as how forwards and options are used in hedging, how they are priced, and what risks do they create. Two full class sessions can be devoted to discussion.