Question

Measuring Economic Exposure. Assume you live in the U.S. Using the following cost and revenue information shown for DeKalb, Inc.,

a) determine how the costs, revenue, and net cash flow would be affected by three possible exchange rate scenarios for the New Zealand dollar (NZ$):

            1) NZ$ = $0.55,

            2) NZ$ = $0.60, and

            3) NZ$ = $0.65.

            b) What is your conclusion?

            15 Marks    

Note: PCF_t is the percentage change in inflation-adjusted cash flows measured in the firm's home currency (U.S. dollars) over period t, and e_t is the percentage change in the exchange rate of the foreign currency over period t.   

Forecasted Net Cash Flows: DeKalb Inc.

(in millions of U.S. dollars and New Zealand dollars)

                                                                                                                               New Zealand

                                                                                            U.S. Business               Business

      Sales                                                                                   $800                         NZ$800

      Cost of Materials                                                               500                               100

      Operating Expenses                                                           300                                     0

      Interest Expense                                                                100                                     0

      Cash Flow                                                                       ($100)                         NZ$700

Answer 1

Forecasted Net Cash flows : Dekalb Inc.
		NS$ = 0.55		NS$ = 0.60		NS$ = 0.65
Sales
U.S.		$800		$800		$800
New Zealand	NZ $800*0.55	440	NZ$800*0.60	480	NZ$800*0.65	520
Total		$1,240		$1,280		$1,320
Cost of materials
U.S		$500		$500		$500
New Zealand	100*0.55	55	100*0.60	60	100*0.65	65
Total		$555		$560		$565
Gross Profit		$685		$720		$755
Operating Expenses
U.S.		$300		$300		$300
New Zealand		0		0		0
Total		$300		$300		$300
EBIT		$385		$420		$455
Interest Expense
U.S.		$100		$100		$100
New Zealand		0		0		0
Total		$100		$100		$100
Earnings before taxes		$285		$320		$355
This previous table shows that Dekalb Inc is highly impacted due to weaker New Zealand dollar value as can be seen that New Zealand business has greater revenue as compared to the expenses