b) Assume FMC enters into a swap arrangement with Morgan Co. In the swap arrange
ID: 2651438 • Letter: B
Question
b) Assume FMC enters into a swap arrangement with Morgan Co. In the swap arrangement, FMC agrees to pay fixed annual interest rate of 6% in dollars and receive LIBOR plus 1.95% in euro every year for the next five years on a notional principal amount of El 0 million (or $15 million at the current spot rate). Re-prepare a schedule that shows FMC's cash payment in dollars to service this debt with the swap arrangement. Will FMC be better of with the swap? Comment. 3. The following schedule shows a US company's revenue and cost compositions by currency. The company produces all of its US sales in the US. but for its Mexican sales, half of the cost is incurred in the US (in $) and half is incurred in peso. Half of its sales are in Mexico, denominated in pesos. The table below shows US ($) Mexico (peso) Total Units sold 10000 10000 20000 Unit selling price $20 200 pesos $20 Total revenue I5200.000 2,000,000 pesos $400,000 Cost per unit $10 $5 + 50 pesos Total Cost $100.000 $100.000 $200,000 Operating margin $100,000 $100,000 $200,000 Assume the Mexican peso depreciates against the US dollar by 20%, that means the new exchange rate will be 12.5 pesos/S. The company can not increase the peso price of its product for if it does, it will lose market share. So the peso price of the Mexican market remains 200 pesos per unit. Calculate the company's operating margin under the new exchange rate and its degree of operating cash flow exposure to exchange rate. Interpret your result. 4. Tsingtao Brewery is contemplating to establish a bottling plant in South Africa. The plant will require initial investment of 100 million Rand, South African currency, which will fully depreciate by the straight-line method over the project's life of five years. In addition, there is a 5 million Rand working capital t investment required to begin the project. Working capital investment will be recovered at the end of the project's life. The fixed assets of the project are expected to be salvaged to net R2 million at the end of the fifth year. The project is expected to generate sales of R75 million during the first year and sales will grow at a constant annual rate of 10% per year. Operating cash costs amount to 60% of sales. South Africa charges income tax at a rate of 20% and China charges 15% tax. China follows the foreign tax deductibility system. The current exchange rate is 0.50Y/R (Yuan per Rand). Future exchange rates can be forecasted based on the forecasted inflation rates in China and S. Africa. Average annual inflation rates in China and S. Africa are estimated at 4% and 5%Explanation / Answer
Ans
Degree of operating cash flow exposure to Exchange risk is 0.75 .ie Any 1% depreciation in Peso will have 0.75% impact in cash flow.
Company has a revenue exposure of 20% which is hedged by incurrence of half of the expendiure in Peso resulting in natural hedge of 5% ,mitigating the total exchage risk.
Details US Mexico Total Peso $ Converted to $ Unit Sold 10,000.00 10,000.00 $10,000.00 $20,000.00 Unit Selling Price 20.00 200.00 $200.00 Total revenue $2,00,000.00 20,00,000.00 $1,60,000.00 $3,60,000.00 Cost Per Unit $10.00 50.00 5 Total Cost $1,00,000.00 5,00,000.00 50,000.00 $90,000.00 $1,90,000.00 Operating margin $1,00,000.00 $70,000.00 $1,70,000.00 Operating Margin before the currency depreciation $2,00,000.00 Revised Operating Margin $1,70,000.00 Dip in Opearating Margin $30,000.00Related Questions
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