Question

MacLoren Automotive manufactures British sports cars, several of which are exported to New Zealand for payment in pounds sterling. The distributor sells the sports cars in New Zealand for New Zealand dollars. The New Zealand distributor is unable to carry all the foreign exchange risk and would not sell MacLoren models unless he could share some of the foreign exchange risk. MacLoren has agreed that sales for a given model year will initially be priced at a base spot rate between the New Zealand dollar and pound sterling set to be the spot mid-rate at the beginning of that model year. As along as the actual exchange rate is within ±5% if that base rate, payment will be made in pounds sterling. That is, the New Zealand distributor assumes all foreign exchange risk. However, if the spot rate at the time of shipment falls outside of this ±5% range, MacLoren will share equally (i.e. 50/50) the difference between the actual spot rate and the base rate. For the current model year, the base rate is NZ$1.64/£.

Source: Mutltination Business Finance by Eiteman, Stonehill, Moffett

a.) If MacLoren ships 10 cars invoiced at £32,000 per car, what would be the total cost to the New Zealand distributor in New Zealand dollars when the cars are shipped at the spot rate of NZ$1.70/£?

b.) If MacLoren ships 10 cars invoiced at £32,000 per car, what would be the total cost to the New Zealand distributor in New Zealand dollars when the cars are shipped at the spot rate of NZ$1.75/£?

c.) If MacLoren ships 10 cars invoiced at £32,000 per car, what would be the total cost to the New Zealand distributor in New Zealand dollars when the cars are shipped at the spot rate of NZ$1.50/£?

Answer 1

a)Total invoice value=£32,000*10=£320,000

Amount in New Zealand dollars as per base rate=1.64*320000=$524,800

Amount in New Zealand dollars as per SPOT  rate=1.70*320000=$554,000

Maximum risk  by New Zealand Dealer =1.05*524800=$551,040

Difference =(554000-551040)=$2960

50%of difference =0.5*2960=$1480

Total cost to NewZealand distributor=$551040+$1480=$552,520

b)when the cars are shipped at the spot rate of NZ$1.75/£

Amount in New Zealand dollars as per SPOT  rate=1.75*320000=$560,000

Maximum risk  by New Zealand Dealer =1.05*524800=$551,040

Difference =(560000-551040)=$8960

50%of difference =0.5*8960=$4480

Total cost to NewZealand distributor=$551040+$4480=$555,520

c)Total cost to the New Zealand distributor in New Zealand dollars when the cars are shipped at the spot rate of NZ$1.50

Amount in New Zealand dollars as per SPOT  rate=1.50*320000=$480,000

Amount in New Zealand dollars as per base rate=1.64*320000=$524,800

NewZealand dollar payable at Minus 5% of Base rate =(1-0.05)*524800=$498,560

Difference =(498560-480000)=$18560

50%of difference =0.5*18560=$9280

Total cost to NewZealand distributor=$498560-$9280=$489,280