carrefour group 8

CARREFOUR S.A. CASE

CASE BRIEF

1 | A p p l i e d C o r p o r a t e F i n a n c e

Introduction

Carrefour S.A is Europe’s largest retailer based in France and is maintaining its retail operation in 26 countries. At the core of Carrefour strategy lays the concept of “Hypermarket”. Hypermarket combines supermarket, drugstore, discount store and gas station into one massive and one stop shopping megastore. By leveraging the idea of “Hypermarket”, Carrefour expanded rapidly inside and outside France adding 4600 new stores in time period of 10 years comprising of 1992 to 2001. In addition to increased number of new stores, Carrefour’s expansion was also fuelled by mergers and acquisitions with other retailing companies i.e. Euromarche and Montlaur. According to Mr Daniel Bernard CEO of Carrefour, the company is going to maintain its growth trajectory. However, in order to finance its growth it is in an immediate need of 750 million euro debt financing. Historically, Carrefour management preferred to fund capital needs in the same currency as the respective operation activities. However, over the course of 1997-2001 euro exchange rates had depreciated against most major currencies. If this trend continues than payment of foreign currency denominated debt with euro denominated cash flows will become increasingly expensive. On the other hand, investment banks have advised Carrefour to consider borrowing in British Pound sterling through the euro-bond market to benefit from opportunity that has risen in that currency. The main issue is that Carrefour management must consider the bond denomination decision which will result in least cost by considering forward interest rates and exchange rates. However, the effect of current interest, interest rate and exchange rates will be critical to the decision.

Analysis and Recommendation

To determine the least costly method of borrowing 750 million Euros we first calculated the forward interest rates; then through forward interest rates we calculated forward exchange rates; then we determined the payments that would be incurred if we borrowed in different currencies; then we recalculated those payments in Euros (through exchange rates) and then finally determined the least costly method/currency to borrow in.

Now we will explain our procedure in detail.


Interbank offer rate and Forward rates

Interbank offer rates for maturity reaching from 1 year to 10 years can be viewed in the following table:

Maturity No of years from initial date EUR GBP CHF USD1 year 1 3.514% 4.258% 1.125% 2.099%2 year 2 3.816% 4.622% 1.713% 2.767%3 year 3 4.110% 4.910% 2.172% 3.432%4 year 4 4.342% 5.088% 2.498% 3.922%5 year 5 4.530% 5.190% 2.743% 4.308%6 year 6 4.688% 5.249% 2.948% 4.619%7 year 7 4.819% 5.292% 3.120% 4.873%8 year 8 4.928% 5.331% 3.267% 5.081%9 year 9 5.017% 5.358% 3.394% 5.264%10 year 10 5.087% 5.374% 3.499% 5.413%

Interbank offer rates will be used in the calculation of forward interest rates as the opportunity cost, as Carrefour foregoes the opportunity to deposit money and earn these rates.

But we can’t use the interbank rates as we need to calculate forward exchange rates, and for calculating forward exchange rates we will need forward interest rates. Forward interest rates for each year can be calculated from the given interbank offer rate by using the assumption that the interbank offer rate follows the zero-curve fixed to floating swap rates formula. Following is the formula we used to arrive at the forward rates,

(1+ I n+m)^n+m = (1+ Y n) ^n *(1+ I m) ^m

Where, I n+m is the interbank rate for n+m years, I m is the interbank rate for m years and Y n is the forward rate the end of year n. Also, n should be less than m for calculation purpose. Suppose we want to determine the 2 year forward rate for Euro currency; the calculation is as follows: ((1.03816)^2)/(1.03514^1))-1 which will give you 4.119%. Similarly we built the whole table for the 4 currencies. Following table presents the summary of the forward rates for each of the four currencies (kindly look at excel for more detail):


Forward Interest Rates1 Year Forward Risk Free rate by currency denomication

Maturity No of years from initial date EUR GBP CHF USD1 year 1 3.514% 4.258% 1.125% 2.099%2 year 2 4.119% 4.987% 2.304% 3.439%3 year 3 4.701% 5.488% 3.096% 4.775%4 year 4 5.041% 5.624% 3.482% 5.406%5 year 5 5.285% 5.599% 3.729% 5.866%6 year 6 5.482% 5.544% 3.979% 6.188%7 year 7 5.608% 5.550% 4.158% 6.410%8 year 8 5.694% 5.604% 4.302% 6.549%9 year 9 5.732% 5.574% 4.416% 6.740%10 year 10 5.719% 5.518% 4.449% 6.764%

Spot and Forward exchange rates:

Following table summarizes the spot exchange rates for the 4 major currencies in which Carrefour can secure the loan (Note: the base currency is euro)

GBP CHF USDEuro 1.593 0.688 1.020

Since we have calculated forward interest rates (see above), we can now calculate the forward exchange rates through the following formula:

FT(F/EUR) = SFR/EUR*(1+RF,T)T/(1+REUR,T)T

Where, FT(F/EUR) represents the forward exchange rate of the exchange rate at the end of a period, SFR/EUR is the spot exchange rate of the foreign currency (which are given above), RF is the risk free rate of return for foreign denominated deposit as determined by the interbank interest rate and REUR is the risk free rate of return as determined by the interbank interest rate for euro denominated deposit. Note the rates over here will be the forward rates for the respective time period that means suppose we want to calculate the forward 2 year exchange rate of pounds. The calculation will be as follows: 1.593 * ((1.03514)^1)/(1.04258)^1)) which will give a 2 year forward exchange rate of 1.582. %. Similarly we built the whole table for the 4 currencies. Following table presents the summary of the forward exchange rates for each of the four currencies (kindly look at excel for more detail):


1 Year Forward Exchange Rates (Base Currency: Euro)

Maturity EUR GBP CHF USD1 year 1.000 1.593 0.688 1.0202 year 1.000 1.582 0.704 1.0343 year 1.000 1.567 0.713 1.0334 year 1.000 1.558 0.721 1.0185 year 1.000 1.558 0.730 1.0066 year 1.000 1.569 0.741 0.9927 year 1.000 1.587 0.750 0.9808 year 1.000 1.599 0.758 0.9679 year 1.000 1.604 0.765 0.95610 year 1.000 1.615 0.770 0.937

Payments

If company wishes to raise capital in foreign currency, the total amount to be raised will be determined on the basis of spot exchange rates. So,

Principal¿ berai sed∈foreign currency (millions)=(750/ Spot exchange rate for foreign currency)millions

If it chooses to borrow simply in Euros then it would simply be 750 million Euros.

The principles in different currencies will be:

EUR 750 million in Foreign Currencies

Currency Amount (in millions)

Euro 750British Pounds 470.810Swiss Francs 1,090.116U.S. Dollars 735.294

Also the coupon rates in the 4 currencies are as follows:


Coupon Rate (10 years) for borrwoing in following Currencies

Currency Coupon Rate

Euro 5.250%British Pounds 5.375%Swiss Francs 3.625%U.S. Dollars 5.500%

Then the coupon payments will be made on the basis of the coupon rate for foreign currency, principal raised at the start and the forward exchange rates of that currency such that,

Coupon payment (millions euros )=Couponrate∗Principal raised∗Forward exchangerate

The initial principal raised at the start will be repaid at the end of the term of bond. The principal amount repaid in term of euro will be determined by the forward at the end of the 10 year period.

Amount repaid∈(millions euros)=Principalraised∈foreign currency∗Forward rate at end of end of 10 years

Assumptions

Annual coupon payments will be made as it is conventional in the euro bond market.

The interbank offer rates are assumed to follow zero-curve fixed to floating swap rate assumption.

Comparison will be made in Euros.

Interbank offer rate are locked for the calculation purpose and they will not change.

All of debt will be financed in only one currency.

Using all this we got the following results with borrowing in Euros (kindly see Excel for more clarity):

Year 1 2 3 4 5 6 7 8 9 10 Total Cost Incurred In Euros

Payments in Euros 39.38 39.38 39.38 39.38 39.38 39.38 39.38 39.38 39.38 789.38 1,143.75


Next, we got the following results with borrowing in Pounds (kindly see Excel for more clarity):

Cash Flows Incurred (in millions) by borrowing in British Pounds (470.8 pounds)


Payments in Pounds 25.31 25.31 25.31 25.31 25.31 25.31 25.31 25.31 25.31 496.12

Payment In Euros 40.31 40.02 39.65 39.42 39.43 39.72 40.17 40.47 40.59 800.99 1,160.76

Next, we got the following results with borrowing in Swiss Francs (kindly see Excel for more clarity):

Cash Flows Incurred (in millions) by borrowing in Swiss Francs (1,090.116 million)


Payments in Swiss Francs 39.52 39.52 39.52 39.52 39.52 39.52 39.52 39.52 39.52 39.52

Payment In Euros 27.19 27.83 28.16 28.48 28.86 29.29 29.63 29.95 30.23 1,120.55 1,380.17

Next, we got the following results with borrowing in dollars (kindly see Excel for more clarity):

Cash Flows Incurred (in millions) by borrowing in U.S. Dollars (735.294 million)


Payments in Dollars 40.44 40.44 40.44 40.44 40.44 40.44 40.44 40.44 40.44 40.44

Payment In Euros 41.25 41.82 41.79 41.16 40.68 40.13 39.63 39.12 38.68 773.17 1,137.44

Final Solution:

As we can see in the tables above the lowest cost incurred is by borrowing in U.S. dollars (Cost incurred in Euros 1, 1 37.44 million Euros). Hence, we recommend borrowing in U.S. Dollars.


carrefour group 8

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