Question

Trident, which is US based company, has many subsidiaries in different countries, such as England, Germany, China etc. Trident Germany, which is one of the foreign subsidiaries of Trident Parent Company, manufactures in Germany, sells domestically and exports and all sales are invoiced in euro. Trident Germany will be affected by the unexpected change in the value of US dollar and euro, the currency of the economic consequence for the German subsidiary. Trident Germany’s baseline assumptions are given as:

	2015	2016
Sales volume (units)	1,000,000	1,000,000
Sales price per unit	€12.80	€12.80
Direct cost per unit	€9.60	€9.60
German tax rate	29.5%	29.5%
Cash operating expenses (fixed)	€890,000	€890,000
Depreciation	€600,000	€600,000
WACC	10 %	10 %

Suppose that on January, 1, 2015, before any commercial activity begins, the euro unexpectedly depreciates from $1.20/€ to $1.12/€. To illustrate the effect of different scenarios on the Trident Germany’s operating exposure, consider two cases;

Case 1: Depreciation, no change in any variable - The euro unexpectedly depreciates from $1.20/€ to $1.12/€. There is no change in Net Working Capital.

Case 2: Increase in sales volume, other variables remain constant – Assume that the depreciation of the euro will result in the sales increase by 40%, to 1,400,000. There is an increase of €203,397 in Net Working Capital.

1. Calculate the present value of the operating cash flows for Case 1.
2. Calculate the present value of the operating cash flows for Case 2.
3. Summarize the impact of the depreciation of the euro in the Trident Germany’s present value.

Answer 1

a). PV of operating cash flow for Case 1 = $3,676,756.36

b). PV of operating cash flow for Case 2 = $4,480,349.24

c). In Case 1, when there is no change in any variable, then depreciation in Euro results in a decrease in PV of operating cash flows in USD since 1 Euro will now convert to less amount of USD due to depreciation. However, in Case 2, where sales volume increase then Euro depreciation effect is nullified and PV of operating cash flows increases over the baseline valuation.