Term paper on Economic variables which should be considered by FedEx financial managers before expanding to Canada

Analysis of investment projects involves evaluation of internal and external environment, and conditions of the project. External environment involves the analysis of local economy and trends in case of starting the project in the same country where the company is operating. If the company is planning to expand overseas, additional macroeconomic variables should be considered, such as government regulations, interest rates, taxation, etc. The purpose of this paper is to discuss the new project of FedEx Corporation supposed to be launched in Canada, and to consider what economic variables should be identified and analyzed before expanding to Canada.

1. Financial data of FedEx Corporation

In order to analyze the appropriateness of the project and the reasonability of expanding to Canada, it is necessary to review key sources of financing and financial variables associated with the supposed project of FedEx Corporation. Table 1 contains information on book and market value of debt and equity financing of FedEx Corporation, and the results of calculating the weighted average cost of capital for this company.

Table 1. Book and market values of debt and equity for FedEx Corporation

In addition to the sources of financing, the state of long-term debt is important for evaluating financial position of the company. Table 2 contains the data on long-term debt of FedEx corporation, and interest rates associated with this debt.

Table 2. Details of long-term debt for FedEx Corporation (FedEx Corporation, 2012)

It is possible to see that FedEx Corporation is using equity as its main source of financing in the USA, according to market estimates. With regard to book estimates of debt and equity, there was only a slight domination of equity financing, which means that market value of FedEx Corporation has increased, and the use of equity financing has been beneficial in this case. In order to evaluate the expediency of investing into new project in Canada, it is necessary to analyze key economic variables affecting the future of the project and cash flows associated with the investment.

2. Key economic variables

To analyze the above-mentioned investment opportunity, it is necessary to consider the state of logistics industry in the selected country, and to consider its state in accordance with Porter’s five forces model. From this point of view, such variables as industry rivalry, the power of suppliers, buyer power, entry barriers and availability of substitute products/services should be considered.

Economic climate in the country can be estimated using several key macroeconomic variables: interest rates (and dynamics of interest rates), inflation trends, availability of commercial lending, employment trends and statistics of unemployment, the dynamics of home construction (and often the dynamics of population) and government spending (Kim, 2011). These variables affect both demand and supply, and can also have an effect on the cash flows of the investment project.

Economic growth of the selected country can be evaluated using the dynamics of GDP, and financial perspectives are driven by monetary policy of the government, and by taxation laws (Kim, 2011). If active interaction with the main office is supposed (project is not autonomous), then exchange rates as well as import and export regulations should also be considered. Such qualitative variables as political stability and the approach to risk-taking common for investors should also be considered by financial managers during evaluating the project.

3. Comparison of economic situation in the USA and in Canada

Overall, the state of logistics industry and delivery services in particular in Canada is largely similar to that of the US. There is intense competition between existing rivals: UPS, DHL, FedEx, and Canada Post. The threat of entry of new competitors is comparatively low, because in this industry, the coverage of delivery network and reputation are highly important, and it is very costly and difficult for a new company to compete with existing rivals. The power of suppliers is low, because the main sphere of activity of FedEx and its rivals are services. The power of customers is very high, because the costs of switching are low, and competition is high. However, in Canada the rate of competition between logistics companies is lower, most likely, due to slower entry of major international competitors to the market.

Government control of economy is more marked than that in the US; for example, labor unions are stronger in Canada than in the US, and the employment in government service industries is significantly higher in Canada. Currently interest rates in Canada are kept at 1%, which is rather low (CIA World Factbook, 2012). Although interest rates in the US are even lower (0.25%), Canadian conditions are also quite favorable for debt financing. However, financial managers should take into account the difference of interest rates. In addition to that, the percentage of taxes and other state revenues in Canada constituted 38.5% in 2011, while for the US this ratio equaled 15% (CIA World Factbook, 2012). Increased taxation base and potentially higher liabilities of an employer should be considered as important factor for evaluating the project’s cash flows (and discounting them, if necessary).

Inflation rate in Canada was only 2.8% in 2011, and only 1.8% in 2010 (CIA World Factbook, 2012). For the United States, this characteristics was 3.0% in 2011 (CIA World Factbook, 2012). Low inflation is a favorable condition for starting a business because NPV analysis is more predictable in such cases. Unemployment rates in 2011 for Canada were 7.40%, and for the US this characteristic was 9.10% (CIA World Factbook, 2012). Overall, the dynamics of economic recovery after recession in Canada has been positive (Giammarino, 1998), and it is reasonable to suggest that there will be favorable economic conditions in Canada for the project’s period. Investments in Canada have slightly different dynamics compared to the USA: Gross fixed investment in Canada was 22.7% in 2011, and in the US it was only 12.40% (CIA World Factbook, 2012).

One significant difference of Canadian financial policy is that its government is tending to keep budget balance close to zero, while the approach of the US government is to rely on significant budget deficit (Williamson, 2011). This feature of Canadian policy increases the financial pressure on new projects.

GDP per capita in Canada constituted $40,300 in 2011 (CIA World Factbook, 2012). For the United States, GDP per capita was $48,100 (CIA World Factbook, 2012). Performance of Canadian workers is estimated as 80% of the performance of similar US workers (Giammarino, 1998). Thus, the economy of the US can be viewed as relatively more efficient, and this should be taken into account when launching the project.

The dynamics of exchange rates of USD and CAD can be estimated using the yield to maturity of US and Canadian government bonds. Applying the results of interest rate parity equation to YTMs, it is possible to suggest that in 6 years, exchange rate of USD and CAD will increase by 0.34%. The stability of Canadian policy and relationships with the US indicate that it is reasonable to suggest that exchange rates will not significant affect the project’s outcomes.

One important feature of Canadian investors is cautiousness and risk-averse behavior (Giammarino, 1998), and these variables should also be considered by financial managers in the process of estimating the investments.

Conclusion

Analysis of economic variables showed that there are both favorable and unfavorable variables affecting the start of new project by FedEx Corporation in Canada. Low interest rates, political stability, solid economic position of the country, low unemployment, stable exchange rates and close collaboration between the United States and Canada are highly favorable for the project. At the same time, higher tax rates, stronger unionization, greater financial pressure on the employer and risk-averse approach of the investors might negatively affect the project’s cash flows, and therefore financial managers should include these variables in the project’s risk assessment and adjust potential cash flows in an appropriate way.