Nokia Analysis Report

András Csizmár, Quyen Vu, Stefanie Weth

International Trade and Finance

ACC3LF003-10
November 2013
 Abstract

24 November 2013

Degree programme in International Business

Author or authors Group or year

András Csizmár, Quyen Vu, Stefanie Weth of entry
LF5PACC
Title of report Number of
Nokia Analysis Report report pages and
attachment pages
29
Teachers
Anne Arkima, Mika Mustikainen

This report was done as an assignment for the course International Trade and
Finance. The company chosen for this project is Nokia Corporation. The material
used in the report was gathered mostly from company’s website and publicly
published documents such as financial statements, news, reports…This report is a
summary of information gathered from those sources and it covers the following
main points:
- company presentation
- international operations and exposure
- different risks in international operations
- payment methods and system
- capital budgeting
- working capital forecast

Each member of the group was assigned a specfic part of the topics covered and
did research on his/her own. The group organized meeting regularly to dicuss
findings, solve problems and assess the progress. This report presents filtered
information and conclusions drawn from group meetings.
Table of contents

1 Company Introduction 1
2 International operations and products 3
2.1 International operations.................................................................................3
2.2 Products.........................................................................................................4
3 International exposure 8
4 Types and description of international trade 11
5 Risk factors in foreign operations and investments 13
5.1 Interest rate risk...........................................................................................13
5.2 Exchange rate risk.......................................................................................14
5.3 Financial risk...............................................................................................15
5.4 Liquidity risk...............................................................................................16
6 Methods of payment 17
7 Currency and Foreign exchange risk hedging methods 19
8 Capital budgeting 21
8.1 Capital budgeting process............................................................................21
8.2 Capital budgeting techniques.......................................................................22
9 Working capital forecast 24
10 Summary 26
References 27
1 Company Introduction

Nokia Corporation, established in Tampere, Finland by Frederik Idestam and Leo

Mechelin, is a communications and information technology multinational
corporation that is headquartered in Espoo, Finland. According to Fortune Global
500 (CNN Money, 2013), Nokia Corporation is the world's 274th-largest company
measured by 2013 revenues.

Nokia is a public limited-liability company, listed on the Helsinki Stock Exchange

as NOK1V and the New York Stock Exchange under the name of NOK. In the
NYSE, one Nokia share costs 7.95 $. The price of the shares has risen drastically
after the announcement of Microsoft buying Devices and Services part from Nokia,
for 5.44 billion EUR. (Nokia Website: Stock charting, 2013)

As of 2012, Nokia employs around 100 000 people over 120 countries, present in
more than 150 countries, and reports annual revenues of around €30 billion. By the
end of 2012, Nokia was the world’s second-biggest mobile phone producer
(concerning unit sales) after Samsung. With that preformance, Nokia obtained
18,0% of the global market share in sold devices.

The firm’s headquarter is situated in Espoo, Finland, but on December 2012, Nokia
announced that they have sold the ”Nokia House” to the Finnish company Exilion.
The price was 170 billion EUR, and from that date, Nokia only leases the head
office. (Infatech, 2012)

Despite the big revenues, the company’s operating profit follows a negative and still
decreasing tendency year by year. In 2012 the operating profit was -2,303 million
EUR. (Nokia Website: Financials, 2013)

On 18 June 2012, Moody's downgraded Nokia rating to junk. (Zacks, 2013)

Nokia CEO Stephen Elop admitted that company's inability to foresee rapid
changes in mobile phone industry was one of the major reasons for the problems
company was facing.

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On 3 September 2013 an agreement has been made which states that Nokia sells
Devices & Services business to Microsoft in EUR 5.44 billion all-cash transaction.

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2 International operations and products

2.1 International operations

Nokia has offices in every countries where they are present. Plus, they operate 8
different production facilities around the world, in 7 different countries. They pay
huge attention minimising any negative environmental and social impact the facility
may have. Reducing energy consumption, or using recyclable materials where
possible. Nokia also attempts to infulence the area’s in a good way, such as
providing rewarding employment opportunities, supporting wothy causes, like
schools, hospitals.

1. South Korea – Masan (Established: 1984) A new state of the art facility,
opened in 2012, promises to be more productive and more sustainable, and a more
enjoyable place to work. Good news for the local community, which already
supplies almost 99% of our workforce, 68% of whom are women.
2. China – Beijing (Established: 1995) Responsible for smartphone and
feature-rich phone production. In 2000, the facility moved into the purpose-built
XingWang industrial park, which clusters Nokia with several key suppliers. This
helps reduce transportation costs, and offers significant savings on energy and
emissions.
3. China – Dongguan (Established: 1995) The Dongguan facility produces
almost a third of Nokia’s entire mobile phone output yet there’s no compromise on
quality. To help maintain the high standards, Dongguan provides internships to
graduate students each year in collaboration with the local university.
4. Mexico – Reynosa (Established: 1996) Around 98% of the workforce
comes from the area and the facility actively supports the local university, schools,
orphanages and shelters. Situated just a few miles from the US border, Reynosa
delivers smartphones to North, Central and South America.
5. Brazil – Manaus (Established: 1998) Chosen as one of the best places to
work in Brazil in 2009 by Exame-Voce S/A guide. Manaus has a strong
sustainability ethos, using eco materials developed locally at INdT to replace
plastics in products and packaging.

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 6. Hungary – Komárom (Established: 1999) Nokia plays a valued role in and
around Komárom. They support the local hospital, fire department and schools, and
Nokia employees help Komárom students learn English. Nokia also funded a
bypass road to the Nokia site, helping relieve traffic congestion and lower emissions
in the area.
7. India – Chennai (Established: 2006) Chennai is one of Nokia’s biggest
facilities,and it’s also big on sustainability. In 2010 it received the Golden Peacock
Award for its high standards of environment management. And it’s highly active in
the community with projects ranging from a local library programme to village
regeneration projects.
8. Vietnam – Hanoi (Established: 2013) Construction is beginning on a new
Nokia facility.

As we could see, Nokia does have international operations, since they don’t have
any production facilities in Finland. They get the materials from the surrounding
countries, and assemble the products abroad. (Nokia Website: Production Facilities,
2013)

2.2 Products

Nokia had many products during the years, starting from paper products, rubber
boots and car/bike tires, to military communication equipment, but since the 1980’s,
Nokia only deals with mobile communication devices and services mainly.
Nokia’s products could be divided into 3 parts: Devices and Services, NSN, and
HERE.

The oldest income source of the company, in charge of producing and selling
mobile communication devices. They Define 3 different device categories, the
Asha-series, the Lumia-series, and the Sybian-series.

Lumia-series: Since the unveiling of the first Nokia Lumia products in 2011, Nokia
has expanded the Lumia experience to new price points and geographies. During the
third quarter of 2012, Nokia announced the Nokia Lumia 820 and the Nokia Lumia

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920, the first devices in Nokia’s Windows Phone 8 range which began to ship in
select markets during the fourth quarter of 2012.
Asha-series: The Nokia Asha family has expanded rapidly since its debut at Nokia
World in October 2011. Nokia Asha products blur the lines between feature phones.
Asha signifies Nokia’s focus on positive user experiences and connecting millions
of people to new opportunities that help them reach their aspirations. In 2012, they
continued to strengthen their Asha portfolio of products, including launching the
first Asha full touch smartphones, such as the Nokia Asha 308 and Asha 309.

Symbian products: During Nokia’s transition to Windows Phone, Nokia continued

to ship devices based on its own smartphone operating system called Symbian.
However, after a decade-long history as part of Nokia’s portfolio, Nokia is not
creating any new devices based on Symbian. The Nokia 808 PureView, a device
which came to market during the first half of 2012, was the last Symbian device
from Nokia. Nokia does not expect to sell any significant volumes of Symbian
devices in 2013.

In the third quarter of 2013, the sold devices and services earned 2,898 million EUR
for the company, which is still a 19% decrease compared to the previous year’s
result. But this 2,898 million is also a +6% change considering the previous quarters
2,724 million EUR sale. Only the sale of smart devices increased from last year, but
Nokia still makes more profit from selling „normal” mobile phones. We must look
at the fact that from the 64.6 million sold devices there were only 8.8 million smart
devices.
At Q3 2013, Nokia’s operating profit were -86 million EUR. The previous year (Q3
2012) it was -872 million EUR, but in the previous quarter, Nokia only lost 33
million EUR. (Q3 Interim report, 2013)

Looking at the full financial year, Nokia sold devices and services for 15,686
million EUR, 34% less than a year before, causing 703 million EUR profit loss, in
comparsion to previous year’s 1,633 million EUR income. (Nokia Website:
Financials, 2013)

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Nokia Solutions and Networks (NSN): formerly Nokia Siemens Networks, is a
multinational data networking and telecommunications equipment company
headquartered in Espoo, Finland and wholly owned subsidiary of Nokia
Corporation. It was a joint venture between Nokia of Finland and Siemens of
Germany known as Nokia Siemens Networks. NSN has operations in around 150
countries. In 2013, Nokia acquired 100% of the company, with a buy-out of
Siemens AG. (NSN, 2013)

Nokia Solutions and Networks had sales worth 2,592 million EUR in Q3 2013,
which is almost 1,000 million EUR less than a year before, causing 26% loss. But
that 2,592 million EUR is only 7% less than the previous quarters results. With this
preformance, NSN’s operating profit were 166 million EUR in Q3 2013, a huge
increase from the previous quarters 8 million EUR, but still 9% loss compared to
Q3 2012. (Q3 Interim report, 2013)

Considering the full financial year, in 2012 NSN’s net sales were 13,779 million
EUR, -2% than in 2011. With this result, NSN was able to provide a 778 million
EUR profit gain in 2012. (Nokia Website: Financials, 2013)

Here (stylised HERE): formerly Ovi Maps (2007–2011) and Nokia Maps (2011–
2012), is a Nokia business unit that brings together Nokia's mapping and location
assets under one brand. The technology of Here is based on a cloud-computing
model, in which location data and services are stored on remote servers so that users
have access to it regardless of which device they use. (Mashable, 2012)
HERE takes the smallest part from Nokia’s revenues, only 4 %. It’s net sales in Q3
2013 were 211 million EUR, -20 % than in Q3 2012. In comparsion with the
previous quarter, which were 233 million EUR, it is a -9 % loss again. (Q3 Interim
report, 2013)
The full financial year’s result in 2012 were 1,103 million EUR, a 2% raise from the
previous year. This result gained Nokia 154 million EUR operating profit. (Nokia
Website: Financials, 2013)

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 Figure 1. Nokia Net sales by business in 2012
(Source: http://www.nokia.com/global/about-nokia/investors/financials/financials/)

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3 International exposure

A company has international exposure, when it goes abroad, not selling and being
present only in it’s home country. Therefore, Nokia definitely has international
exposure for the last 30 years at least. Not even selling only products and services,
but as stated above, having production facilities in 7 different countries, running
offices in almost all of the countries they are present. Nokia pays attention to it’s
costumers, providing various options choosing language at their web-page, for
example.

Figure 2. Nokia net sales by geographic area in 2012

(Source: http://www.nokia.com/global/about-nokia/investors/financials/financials/)

Taking a look at the geographical place of sales, we can see that in 2012 Europe
was the biggest area of net sales with it’s 29%, followed by the Asia-Pacific area
right after with 27%.

Interesting fact, that North America has the smallest part among sales, with only
7%, but according to the Q3 Interim Report, the North American area was the only
one who grew, and with a huge percentage, 44% in a year-over-year view. All the
other areas have decreased, the major decreases happened in the Middle East &
Africa (33%), and in the Asia-Pacifics (30%). That could mean that in the not so

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improved countries people are can not really afford the newest Smartphones maybe.
(Nokia Website: Financials, 2013)
Just taking a quick look at NSN’s sales, and we can see that it’s main target is Asia
and the Middle east, then comes Euripe and Africa, and the Americas at last.

Figure 3. Nokia Siemens Network net sales by geographic area 2012

(Source: http://i.nokia.com/blob/view/-/2268488/data/3/-/NSN-form-2013.pdf)

Nokia has employees in all around the world.

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 Figure 4. Nokia personnel by geographic area 2012
(Source: http://www.nokia.com/global/about-nokia/investors/financials/financials/)

35% of the people are working in Europe, then in the Asia-Pacific region, and then
Greater China. Europe is the main region, because of the origin and the headquarter
of the company, then comes Asia-Pacific and Greater China, because of the
production facilities.
With all the dismantles, Nokia had to dismiss half of their personnel in the South
American region in the last year. They also disposed almost 10,000 employees from
Europe, and 2,000 from the Asia-Pacifics, causing 26 and 23% personnel decrease
in these regions. (Q3 Interim report, 2013)

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4 Types and description of international trade

It is not easy to define and describe the firm’s international trades, since they are
working with a lot of other companies worldwide. But the international trade starts
at the beginning of the production, due their 8 production facilities outside Finland.
Nokia tries to solve everything which is possible in-house, and only after that they
ask for suppliers.
So in the first case, they have international trade with the suppliers during the
process of manufacturing. It could be raw material, like tin mined in Indonesia. It
could also be half-finished parts for the assembling process, or even fully finished
parts or accessories. Nokia pays great attention choosing the best suppliers and
trading partners.
Nokia does not directly sell their own products even though they have offices in
every country, they are just service and recycle points. Most of the sales happen
through resellers, or mobile providers. Which means the resellers and mobile
providers buy the devices from Nokia and sell it to the costumers.
As every big company, Nokia also has subsidiaries. (Sec, 2013)

Company    Country of Incorporation

Nokia Inc.    United States
Nokia GmbH    Germany
Nokia UK Limited    England & Wales
Nokia TMC Limited    South Korea
Nokia Telecommunications Ltd.    China
Nokia Finance International B.V.    The Netherlands
Nokia Komárom Kft.    Hungary
Nokia India Pvt. Ltd.    India
Nokia Italia S.p.A.    Italy
Nokia Spain S.A.U.    Spain
Nokia Romania S.R.L.    Romania
Nokia do Brasil Tecnologia Ltda    Brazil
OOO Nokia    Russia
NAVTEQ Corporation    United States
Nokia Siemens Networks B.V.    The Netherlands
Nokia Siemens Networks Oy    Finland
Nokia Siemens Networks GmbH & Co
KG    Germany
Nokia Siemens Networks Pvt. Ltd.    India

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The largest in terms of revenues is Navteq, a Chicago, Illinois-based provider of
digital map data and location-based content and services for automotive navigation
systems, mobile navigation devices, Internet-based mapping applications, and
government and business solutions. Navteq was acquired by Nokia on 1 October
2007. Navteq's map data is part of the Nokia Maps online service where users can
download maps, use voice-guided navigation and other context-aware web services.
(Navteq, 2013)
These subsidiarities funciton as a regional center, all the trades are going thorugh
them. For example Nokia Komárom Kft. is responsible for all the production of the
facility in Komárom, trading the products in the area, accounting, reporting.

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5 Risk factors in foreign operations and investments

Nokia as a global operating company with international investments has to consider

various risk factors influencing their business. In the following these factors will be
analysed, discussed and elaborated. Risks referring to the operations of Nokia are
market risks - such as interest rate risk and foreign exchange rate risk, credit risks
and liquidity risks. Equity risk is not to be faced respectively not relevant since
Nokia’s equity price is based on the value of its shares.

Nokia sells on an international base in nearly every country and has productions
facilities in Brazil, China, India, Hungary, Mexico, South Korea and Vietnam.
(Nokia website, 2013).

Before discussing the risks in detail it should be mentioned that the Value-at-Risk
(VaR) methodology - calculated by the Monte-Carlo-Simulation - is utilised to
reveal and evaluate potential risk (Nokia 2012 Financial statements). The Value-at-
Risk methodology is a tool used by many companies and banks. It measures the
probability of not losing a fixed amount of money in a fixed time considering an
investment. The Monte-Carlo-Simulation can take a complete portfolio with various
investments and operations into account and shows estimated potential losses,
which will be referred to as VaR figure in the following. (Hull, 2010)

5.1 Interest rate risk

A major risk evolving from Nokia’s foreign operations is the interest rate risk,
whereas the challenge lays in the comprehensive operations of the global Group.
Since interest rates are set by monetary policies through central banks (Husted &
Melvin, 2012) each currency operated has to be analysed and observed. Hereby is
the focus on the vulnerability of fluctuations in the profit made through liabilities
and assets. Assets can be considered as for example foreign currency reserves since
the position “bank and cash” is quoted with an overall of 3,504 million Euros and
liabilities as credits granted by local banks. The VaR figure of interest rate exposure
as an average for the year 2012 was 19 million Euros, which is a significant change

13
to the 34 million Euros in 2011. To minimise those risk certain derivatives are used,
which will be shown in detail in the chapter “currency and foreign exchange risk
hedging methods”. (Nokia 2012 Financial statements)

5.2 Exchange rate risk

Nokia faces foreign exchange rate risk as well which evolves from fluctuation in
exchange rates. This risk can be divided in two major parts, the translational and
transactional risk (Nokia 2012 Financial statements). Translational risk is risk
arising from the translation of financial statements of subsidiaries in countries with
other currency then the home currency of a Group. While translating assets,
liabilities, gains, losses, revenues and expenses changes in foreign exchange rates
between different reporting dates can cause exchange rate losses or gains. (Shapiro,
2010) Over the past three years Nokia has actually gained from translation to wit
1,302 million Euros in 2010, which decreased to 9 million euros in 2011 and went
up again to 39 million Euros in 2012 (Nokia 2012 Financial statements).
Transactional risk arises from changes in foreign exchange rates from the date
where an agreement is signed to the date the agreement is accomplished, so it has a
direct impact on the cash in- and outflows of a company (Shapiro, 2010). In our
case “transaction risk arises from foreign currency denominated assets and
liabilities together with foreign currency denominated future cash flows” (Nokia
2012 Financial statements, p.F-72). The company has suffered foreign exchange
losses of – 346 million Euros in 2012 and – 108 million Euros in 2011. The four
main currencies Nokia faces exposure to are the United States Dollar, the Japanese
Yen, the Chinese Yen and the Indian Rupee, which are the currencies that make an
integrant part of the currencies hedged. Hedging methods will be described in detail
in the chapter “currency and foreign exchange risk hedging methods”. The VaR
figure for foreign exchange risk includes “available-for-sale investments, loans and
accounts receivables, Investments at fair value through profit and loss, cash, loans
and accounts payable […] FX derivatives designated as forecasted cash flow hedges
[…] FX derivatives designated as forecasted cash flow hedges and net investment
hedges” (Nokia 2012 Financial statements, p.F-74). The Average for the year VaR

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figure was 128 million Euros in 2012, which stands for a decrease in risk as VaR
figure in 2011 was 218 million Euros. (Nokia 2012 Financial statements)
Credit risk is another common risk which is faced not only in foreign operations and
investments. It is the risk of defaulting receivables. There are different methods and
sources to analyse the credit worthiness of business partners. One commonly used
source would be rating agencies such as Moody’s, Fitch and Standard and Poor’s,
banks, but also financial reports published by the company itself. When expanding
especially to rather precarious countries, sources of information might not be
reliable, since reporting standards and regulations are weak (Hull, 2010). As for
Nokia credit risk is divided into business related credit risk and financial credit risk.
Business related credit risk refers to risk develop from receivables and loans to
business partners. To handle this risk Nokia has implemented internal rating
policies, which supervises credit risk concerning customers or third parties.
Accounts receivable includes all outstanding receivables or loans was 5,551 million
Euros in 2012 whereas in 2011 it was 7,818 million Euros. After proper research on
customers and third parties credit history and worthiness the Group gives the
possibility for doubtful accounts. The allowance for doubtful accounts and expected
uncollectible receivables was 1,727 million Euros in 2012 and 2,109 million Euros
in 2011. The provision on these was a total of 264 million Euros in 2012 and 395
million Euros in 2011. Receivables that have not been paid past due make a total of
365 million Euros in 2012 and consist of the three categories: past due 1 – 130 days
250 million Euros, 31-180 days 70 million Euros and more than 180 days 45 million
Euros.

5.3 Financial risk

Financial credit risk concerns risk emerging from financial instruments. This risk is
managed by the Treasury department of Nokia and has the purpose of concentrating
the number of partners to a rather small number of banks and financial providers to
supervise their creditworthiness. Netting Arrangements are arranged with all main
counterparties as well as collateral agreements. In 2012 there was a total of
outstanding fixed income and money market investments of 6,405 million Euros
provided mainly by banks and governments.

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5.4 Liquidity risk

If some parties default on their receivables, this can lead into liquidity risk though
liquidity risk originates for various reasons. Liquidity risk must not be mistaken
with solvency, which counts for a company having more assets than liabilities and
therefore a positive equity. If a company suffers from liquidity problems it has
simply not enough current assets to cover for their daily business. (Hull, 2010)
Since Nokia as a globally operating company needs to hedge for many risks,
especially once accruing from interest and exchange rate risk which tides up money
proper cash management is needed. The mobile industry is also considered as
capital intensive, due to high costs for research to compete in an innovative market.

Cash management is based on short-term investments with securities that can be

liquidised on short notice. Furthermore committed and uncommitted credits are kept
available for unexpected happenings. (Nokia 2012 Financial statements)

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6 Methods of payment

Being involved in international trade requires a proper cash management including

effective payment terms. Considering Nokia as an exporting company there is a
certain amount of money needed to meet purchase agreements of customers before
getting any payments back. There are usually three ways on how costs for
production, transport and inventory holdings are financed. The first option is for the
exporter two carry all financial needs, the second option is for the importer two
carry all financial needs and the third option is for the two parties to meet
somewhere in the middle. This is due to the fact that a minimised risk for the
exporter means less attractive terms of payment for the importer and lead to losses
in sales. One approach would be the so called cash in advanced which is basically
the payment of the goods by the importer before shipment or arrival of the goods.
This gives the exporter highest security and is usually used when the importer’s
creditworthiness is doubted or importer’s local market does not supply proper
banking system (Shapiro, 2010). In the case of Nokia it should be considered that
products are sold in nearly every country in the world. Orders of end consumers
directly to the Nokia Group have usually this term of payment (Nokia Website,
2013). The letter of credit is a guarantee of a bank for the exporter that the importer
will meet its payments. This method gives both sides security, since the exporter
gets the guarantee of payment and the importer is able to see condition of the goods
shipped before actually paying. A draft can be used as well it is a letter from the
exporter to the importer that demands the payment for the goods on a fixed date
with a fixed amount. A rather risky method for the exporter would be the shipment
of goods on consignment. This means that goods are shipped but only paid if the
importer has sold them to its customers. (Shapiro, 2010) Nokia does not make use
of this term since it is stated that the ownership of goods goes to its buyer with the
shipment of the goods (Nokia 2012 Financial statements). The last method to be
discussed is the so called open account selling which basically means that shipment
is made first and afterwards the exporter invoices the amount agreed on. This
reveals high risk to the exporter (Shapiro, 2010).

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Nokia payment terms are written in credit policies, providing some of its customers
with special agreements which give them extended terms of payment. These
customers are reconsidered and analysed every year to reassure they meet certain
creditworthiness. If customers default on their receivables Nokia minimises this
risk by selling these receivables to third party financial institutions. As it was said in
the chapter risk factors of foreign operations and investments Nokia consist of
netting arrangements with all its main trading partners as well as occasional
collateral agreements. Furthermore Nokia uses letters of credit, insurances,
collaterals and other instrument to secure payments (Nokia 2012 Financial
statements).

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7 Currency and Foreign exchange risk hedging methods

As it was discussed in the chapter risk factors in foreign operations and investments
the risk of fluctuating interest and foreign exchange rates result to risks for a
company. To minimise this risks there are certain hedging methods. Operations
hedged and included into hedge accounting are named by the company as (Nokia
2012 Financial statements, p. F-17, pp).
 Cash flow hedges: Hedging of forecast foreign currency denominated sales
and purchases
 Cash flow hedges: Hedging of foreign currency risk of highly probable
business acquisitions and other transactions
 Cash flow hedges: Hedging of cash flow variability on variable rate
liabilities
 Fair value hedges
 Hedges of net investments in foreign operations

When hedging forecast foreign currency denominated sales and purchases the cash
flows of this sales and purchases, foreign currency risk of highly probable business
acquisitions and other transactions and cash flow variability on variable rate
liabilities these cash flows must clearly show the risk of exposure to fluctuations
and the impact it will have on the financial outcome of the company. It is defined
that hedges must be considered as effective. This means that expected changes in
the spot rate market should not exceed the difference of the spot rate and the
forward rate in a way that causes inefficiency. Options should only be utilized if the
fair value of the option includes any changes in the intrinsic value to secure the
effectiveness of the option. If costs of hedging over- or underestimate the real fair
value of the option it will either show as revenue and expanses or as profit and loss.

Fair Value hedges are hedges with the purpose of minimising risk referring to
fluctuation of value in interest-bearing liabilities by volatile exchange- and interest
rates.

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More difficult to hedge are net investments since it consist of both cash flows and
fair value hedges. (Nokia 2012 Financial statements)
Nokia hedges this risk through forward exchange rate contracts, options and interest
rate derivatives such as interest rate swaps (Nokia 2012 Financial statements). A
forward market is a market where currencies are traded and has the purpose to
secure exchange rates at a certain point in the future. Options have the same purpose
of securing certain exchange rates in the future. They can either be bought or sold.
As a buyer you pay the option fee and it leaves you the option to back out of the
contract if the spot market reveals a more economical rate. Interest rate swaps is a
contract which obliges its two members to exchange interest. Interest rates agreed
on can either be a mixture of floating and fixed exchange rates or both parties agree
on floating exchange rates but based on different rates. (Shapiro, 2012)

In 2012 Nokia has made forward foreign exchange contracts worth the amount of
10,615 million Euros and bought currency options of 1,123 million Euros, sold
currency options worth 283 million Euros and interest rates swaps of 615 million
Euros as derivatives that are not included in hedge accounts. 3,359 million Euros
counted for hedges of net investment in foreign subsidiaries and 6,127 million
Euros counted for hedges in cash flows and where in form of forward foreign
exchange contracts. Interest rate swaps were purchased to hedge fair value worth
1,780 million Euros and cross-currency interest rate swaps both to hedge cash flows
and fair value worth 420 million Euros. (Nokia 2012 Financial statements)

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8 Capital budgeting

8.1 Capital budgeting process

The process of capital budgeting in Nokia is not different from other small or
medium-sized companies. Throughout the year, the company gathers proposals
from all of its divisions. These proposals come from even smaller units such as
manufacturing plants, sales offices… There could be hundreds of proposals a year
in a division so the task of divisional managers is to filter out the most feasible and
profitable investment plans to propose to top management. The filtered plans will
then be presented to senior managers, who will make decisions on whether to
follow these plans. Capital budgeting in Nokia is performed annually and under the
supervision of the company’s Board of Directors. The Board of Directors is
responsible for setting annual ranges or individual limits for capital investments,
expenditures, divestitures or financial commitments. The Board consists of three
committees: Audit Committee, Corporate Governance and Nomination Committee.
Out of which, the Audit Committee has special importance in supporting the Board
when making capital budgeting decisions. The Audit Committee mainly supervises
internal financial accounting process but also involves in risk management (Nokia
2012 Financial statements, p.160). Any investment proposal would have to be
assessed by the Audit Committee before being approved by the Board. The purpose
is to ensure the risks in these investments do not stay out of the company’s risk
policies. Any plan passed through the assessment by the Audit Committee is then
reviewed by the Board. At this point as the projects are rated safe enough to invest,
the further selection process is based on other criteria such as the company’s long-
term strategy, shareholders’ value, corporate policies…A list of approved
investment plans is drafted which makes up the company’s capital budget for the
next year. A formal request, which includes detailed analysis, future cash flow and
backup plans for each of the approved project, is required to make this budget
official. After the request is signed by the Board, it officially becomes the capital
budget for the following year and is issued to all company divisions.

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Since Nokia is a big multinational corporation, top managers residing in
headquarters in Finland cannot oversee the whole process of capital budgeting in all
of its overseas divisions. Therefore, management in its foreign divisions retain some
control over their capital budget, which is set by certain ceilings on the sizes of
projects divisional managers can authorize themselves. Nokia’s subsidiaries abroad
are mostly responsible for their own budget. However, the capital outlay still has to
be reported to the headquarters. Important investment decisions concerning
subsidiaries are also performed by top managers at headquarters.

Nokia as one of the giants in mobile phone and telecom sectors invests heavily in
developing new technological products. Thus a big portion of annual budget is
devoted to R&D projects, especially for the smart phone lines. In recent years, the
company has not been doing very well and is closing some of its production
operations in Europe and North America, reducing investments in its Location &
Commerce segment. Instead, budget for these investments is switched to other
segments. In 2012, Nokia incurred €461 million of capital expenditures in total, out
of which €216 million was invested in Nokia Siemens Network and €180 million
went to developing Devices and Services segment (Nokia 2012 Financial
statements).

8.2 Capital budgeting techniques

Nokia employs the primary methods in capital budgeting which are:

 Net present value (NPV)
 Internal rate of return (IRR)
 Payback period

A project first needs to have a positive NPV in order to be profitable. NPV is

calculated as the total sum of discounted future cash flows minus the cost of
investing in the project. Future cash flows are discounted at a hurdle rate computed
as the total of the company’s cost of capital rate and risk premium rate of that
particular project. (Brealey, Myers & Allen, 2011)

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Another technique which is more commonly used is IRR. IRR is calculated by
dividing expected profits by expected expenditure to arrive at a percentage called
the rate of returns. This percentage will then be compared with the company’s
hurdle rate. If it exceeds the hurdle rate, this project is worthwhile. If not, it means
the project does not generate enough profits to meet the minimum acceptable rate of
returns (the hurdle rate) and thus, is not worth pursuing. IRR comes in handy when
managers have to decide between two projects with similar positive NPVs. Since
the company may not have the financing needed to invest in both projects, only the
one with higher IRR should be retained, unless the company gains other strategic
benefits investing in lower ones. (Brealey, Myers & Allen, 2011)

In the payback method, the company invests in a project and allows a certain
amount of time for it to return profits. If the project generates profits exceeding the
upfront investment by a specified cut-off date, it should be accepted. This method is
used especially for short-lived projects or when the company has difficulties raising
capital. (Brealey, Myers & Allen, 2011) Nokia for example sets a three-year
payback period for investments in goodwill, since these suffer from impairment lost
and are rather short-lived investments. (Nokia 2012 Financial statements, p.F-35)

Depends on the nature of the project, Nokia may use one technique or another.
Minor techniques such as profitability index, sensitivity analysis, scenario analysis
can also be used to determine how a project pays off. The Monte Carlo simulation
(as mention in section 2) is another convenient tool to forecast all the possible
outcomes of a project. Of course all projects cannot be accurately forecasted. Most
of Nokia’s projects concern developing new technological devices, whose sales
volume depends heavily on market demand. Nokia may find the need to modify its
projects after initiating them. For example, the company usually launches new
products, tests the market demand and then further decides if it should expand or
abandon the project. This could be considered a technique, although this is mostly
reserved for large companies with no problem raising capital.

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9 Working capital forecast

In order to forecast the working capital for next year, Nokia has to forecast the
following main items:
 Future revenue growth
 Future operating costs growth
 Changes in net working capital

By looking at historical data, the company can forecast the future trend. Below is
Nokia’s result of operations for the years 2012 and 2011.

Figure 5. Nokia results of operations in 2011 and 2012

(Source: Nokia 2012 Financial statements, p. 106)

As can be seen from the results, Nokia has had negative operating profit in two
consecutive years. Sales revenue has declined a dramatic 22% from 2012 to 2011
which resulted in the similar decline rate in COGS. Along with decreasing sales,
operating costs such as R&D, selling, marketing, administrative…costs also shrank
by roughly 14%. Nokia’s current assets and liabilities accounts also contracted
around 16% each as a result of sales contraction.

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 Figure 6. Nokia Current assets and Current liabilities accounts in 2011 and
2012
(Source: Nokia 2012 Financial statements, p. F-4)

Working capital for 2011 = Current assets 2011 – Current Liabilities 2011
= 25455 – 17444 = 8011
Working capital for 2012 = Current assets 2012 – Current Liabilities 2012
= 20878 – 14646 = 6232
Change in working capital = 8011 – 6232 = 1779

From 2011 to 2011, Nokia has reduced its holding of working capital by 22%, the
same decline rate of sales revenue, thus proves the tight correlation between those
two items, as according to theory. If this trend persists into the next year, there
would be further reduction in working capital unless sales volume improves. The
company estimate potential sales revenue in several scenarios and adjust its working
capital to an appropriate level in each scenario. The point is to maintain adequate
inventories to meet demand yet ensure not too much assets is tied up, thus provides
the company liquidity to invest in other current assets. Nokia as a big corporation
does not have difficulty meeting liquidity requirements since the company has many
credit lines reserved at many banks, plus the fact that it can issue more marketable
securities such as commercial papers for cash. However, production managers,
credit mangers and financial managers of Nokia have to work together to ensure a
reasonable amount of working capital is available.

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10 Summary

Nokia Corporation was a very interesting case study. The company diverse
international operations and services provide a good opportunity for our group to
learn about international trades in a multinational corporation. Nokia as a struggling
business in the technology sector faces many risks and problems that require
detailed planning, advanced hedging methods and tight control. However, in some
aspects such as capital budgeting and working capital management, it is no different
than smaller or medium-sized companies, which employ the same basic techniques.
The deal with Microsoft has structurally and strategically changed Nokia. The
company’s long-term development now depends partly on its partner. Time will tell
whether Nokia will return to be the leader in mobile and telecom technology.

26
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