Question

Goldmines Inc. (fictitious name) mines, refines, and sells gold in the world market. The company’s profits move in tandem with Economic Growth. Assume that the following data (Amounts in millions $) and respond the the question given below:
Economic Condition	Probability	Pre-Tax Profit
High Growth	40%	260
Low Growth	60%	0
Tax Rate	30%
Profit if Firm is Hedged	100
Loss Carry Forward	40

Scenario 1	There is no Tax
Profit if Firm is Hedged
Profit if firm is not hedged
Should Firm Hedge?
Scenario 2	There is Tax
Profit if Firm is Hedged
Profit if firm is not hedged
Should Firm Hedge?
Scenario 2	There is Tax and Loss Carry Forward
Profit if Firm is Hedged
Profit if firm is not hedged
Should Firm Hedge?

Answer 1

Scenario 1:	If There is no Tax
a) profit if not hedged
Economic Condition	Probability (a)	Pre-Tax Profit        (b)	Expected Retrun          (c) = (a) * (b)
High Growth	40%	260	104
Low Growth	60%	0	0
Total Expected Pre-Tax Profit without Hedging	104
b) Profit if hedged		100
Suggestion: it is advisable not to hedge since it gives more Income

Scenario 2:	If There is Tax
a) profit if not hedged
Economic Condition	Probability (a)	Pre-Tax Profit        (b)	Expected Retrun          (c) = (a) * (b)
High Growth	40%	260	104
Low Growth	60%	0	0
Total Expected Pre-Tax Profit without Hedging	104
Less: Tax @ 30%	31.2
Total Expected After Tax Profit without Hedging	72.8
b) Profit if hedged
Profit Before Tax if Hedged	100
Less: Tax @ 30%	30
Profit after Tax	70
Suggestion: it is advisable not to hedge since it gives more Income

Scenario 3:	If There is Tax & carry forward loss
a) profit if not hedged
Economic Condition	Probability (a)	Pre-Tax Profit        (b)	Expected Retrun          (c) = (a) * (b)
High Growth	40%	260	104
Low Growth	60%	0	0
Total Expected Pre-Tax Profit without Hedging	104
Less: Tax @ 30% on (104-40) = 30% of 64	19.2
Total Expected After Tax Profit without Hedging	84.8
b) Profit if hedged
Profit Before Tax if Hedged	100
Less: Tax @ 30% on (100-40) = 30% on 60	18
Profit after Tax	82
Suggestion: it is advisable not to hedge since it gives more Income