Question

Grand Tour Co. does business in United States and Australia. Grand Tour Co. conducts a sensitivity analysis to check whether its cash flow is affected by changes in the value of the Australia dollar. Grand Tour Co.’s sales revenue from U.S.A. is affected by the value of the Australia dollar. The higher the value of the Australia dollar the less competition from Australia firms, and the more products they can sell in U.S.A. There are three possible exchange rate scenarios for the Australia dollar: A$ = $.48, A$ = $.50, and A$ = $.54. A$ refers to Australia dollars. Premier’s U.S. sales forecasts based on the three exchange rate scenarios is below.

                                                                                              Revenue from U.S. Business

                           Exchange Rate of A$                                 (in millions)

                                   A$ = $.48                                              $100

                                   A$ =      .50                                                105

                                   A$ =      .54                                                110

Premier’s sales revenues from Australia are expected to be A $600 million.

                    The forecasted Net Cash Flows for Premier Company are below.

                    The figures are in millions.

                                    A$ = $.48                   A$ = $.50                   A$ = $.54

Sales

      U.S.                                            $100                            $105                            $110       

      Australia A$600 =     288           A$600 =     300           A$600 =     324

      Total                                           $388                            $405                            $434

Cost of materials

      U.S.                                            $200                            $200                            $200

      Australia                  A$100 =         48           A$100 =         50           A$100 =         54

      Total                                           $248                            $250                            $254

Operating expenses

      U.S.: Fixed                                  $ 30                             $ 30                             $ 30

      U.S.: Variable (20%

          of total sales)                               78                                 81                                 87

      Total                                           $108                             $111                             $117

Interest expense

      U.S.                                            $ 20                             $ 20                             $ 20

      Australia                 A$0 =               0           A$0 =               0           A$0 =               0

      Total $ 20                             $ 20                             $ 20

Net Cash Flows                                 $ 12                             $ 24                             $ 43

1. Is the cash flow of Grand Tour Co. sensitive to movements in the exchange rate of the Australia dollar? Why?
2. Does Grand Tour Co. suffer from economic exposure, or translation exposure?
3. If Grand Tour Co. shifts some of its expenses from U.S. to Australia, will this reduce its exposure?

Answer 1

			(In Millions)
			A$ = $ 0.48		A$ = $ 0.50		A$ = $ 0.54
Sales
	U.S.		$         100		$         105		$         110
	Australia	A$ 600	$         288	A$ 600	$         300	A$ 600	$         324
	Total		$        388		$        405		$        434
Cost of Materials
	U.S.		$         200		$         200		$         200
	Australia	A$ 100	$          48	A$ 100	$          50	A$ 100	$          54
	Total		$        248		$        250		$        254
Operating Expenses
	U.S. Fixed		$          30		$          30		$          30
	U.S. Variables		$          78		$          81		$          87
	Total		$        108		$        111		$        117
Interest Expense
	U.S.		$          20		$          20		$          20
	Australia		$           -		$           -		$           -
	Total		$          20		$          20		$          20
Net Cash Flows			$          12		$          24		$          43
Answer:- Yes, Cash flow of Grad Tour is sensitive to movements in the exchange rate of Australia dollar. Why? Because Grand Tour is running a business in Australia and Australian firms has competition in USA also. Due to Economic exposure, if Australian dollar is strong, which means U.S. dollar goes down. In such case, export from australia firm decrease because purchase power decrease due to increase in australian dollar. And also Grand Tour export will increase, if the price of items remian same because it is cheaper to australia to import such items. Yes, Grand Tour Co. suffer from economic exposure as discussed above. If, Grand tour has a P/E in australia in such case it will also face translation exposure. Yes, if Grand Tour transfer some of its expenses, it will reduce exposure. Now, grand tour incurred all operating expenses in U.S. if it will shift some such expenses related to Australia, it will reduce cash flow from Australia. Now, if Australia dollar decrease, in such case, transaction exposure of Grand Tour to convert the money will drecrease.