Question

St. Paul Co. does business in the United States and New Zealand. In attempting to assess its economic exposure, it compiled the following information.

      a.   St. Paul’s U.S. sales are somewhat affected by the value of the New Zealand dollar (NZ$), because it faces competition from New Zealand exporters. It forecasts the U.S. sales based on the following three exchange rate scenarios:

                                                                               Revenue from U.S. Business

                         Exchange Rate of NZ$                              (in millions)

                                   NZ$ = $.48                                             $100

                                   NZ$ =   .50                                                105

                                   NZ$ =   .54                                                110

      b.   Its New Zealand dollar revenues on sales to New Zealand invoiced in New Zealand dollars are expected to be NZ$600 million.

      c.   Its anticipated cost of materials is estimated at $200 million from the purchase of U.S. materials and NZ$100 million from the purchase of New Zealand materials.

      d.   Fixed operating expenses are estimated at $30 million.

Variable operating expenses are estimated at 20 percent of total sales (after including New Zealand sales, translated to a dollar amount).

      f.    Interest expense is estimated at $20 million on existing U.S. loans, and the company has no existing New Zealand loans.

      Forecast net cash flows for St. Paul Co. under each of the three exchange rate scenarios. Explain how St. Paul's projected net cash flows are affected by possible exchange rate movements. Explain how it can restruc­ture its operations to reduce the sensitivity of its net cash flows to exchange rate movements without reducing its volume of business in New Zealand.

Answer 1

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The forecasted statement of income reflects that this company stands be affected favourably due to strong NZ dollar currency as the statement clearly reflect that the inflow payment associated with the NZ$ is more than the outflow payment of NZ$. The economic exposure can be reduced by St. Paul Company without decreasing the revenues by making a shift in expenses from united stated to New Zealand. With such an arrangement the outflow payment in NZ$ stands to be similar to inflow payments in NZ$