Question

Xiling Co. is a U.S. company with sales to Canada amount­ing to C$8 million. Its cost of materials attributable to the purchase of Canadian goods is C$6 million. Its interest expense on Canadian loans is C$4 million. Given these exact figures above, the dollar value of Whitewater’s “earnings before interest and taxes” would _______ if the Canadian dollar appreciates; the dollar value of Whitewater’s cash flows would _______ if the Canadian dollar appreciates.

Answer 1

Since Xiling Co. is a U.S. company selling in Canada, the earnings from Canada have to be repatriated to U.S. by converting them from C$ to $. Also, the payment of the Canadian loan have to be made in C$ which means that $ have to be converted to C$. The following table below show the earnings before interest and tax and the cash flows of the Xiling Co. in C$:

Particulars	Amount ( in C$)
Sales	8,000,000
(-) Cost of Materials	6,000,000
Earnings before interest and tax	2,000,000
(-) Interest	4,000,000
Earnings before tax	-2,000,000

If Canadian $ appreciates, let us suppose earlier 1 C$ was equal to $0.70 and now it has appreciated to $0.80 then 1 C$ is going to fetch more dollars than before.

Then, the $ value of Earnings before Interest and tax at previous rate = (2,000,000 x 0.70) = $1,400,000

The $ value of earnings before interest and tax at new rate = (2,000,000 x 0.80) = $1,600,000

Answer: Therefore, the dollar value of earnings before interest and tax would appreciate if the Canadian dollar appreciates as is evident from the above calculation.

In the above case, since interest payments on loan have to be made in C$ so when it appreciates the company would have to shell out more $ to obtain a C$ than before which would further reduce the dollar value of its cash flows. As the company has to pay more as interest on its C$ loans whose value has increased.