Question No: 2

1. American Corporation, a US company, formed a British subsidiary on January 1, 2015 by investing £450,000 in exchange for all of the subsidiary’s no-par common stock. The British subsidiary, London Corporation, purchased real property on April 1, 2015 at a cost of £500,000, with £100,000 allocated to land and £400,000 allocated to a building. The building is depreciated over a 40-year estimated useful life on a straight-line basis with no salvage value. The British pound is London’s corporation functional currency and its reporting currency. The British economy does not have high rates of inflation. Exchange rates for the pound on various dates were:

           January 01, 2015      = 1£ = $1.50

           April 01, 2015          = 1£ = $1.51

           December 31, 2015 = 1£ = $1.58

           2015 average rate     = 1£ = $1.56

   London's Corporation adjusted trial balance is presented below for the year ended December 31, 2015.

   			In Pounds
   Debits:
   Cash	£		220,000
   Accounts receivable			52,000
   Inventory			59,000
   Building			400,000
   Land			100,000
   Depreciation expense			7,500
   Other expenses			110,000
   Cost of goods sold			220,000
   Total debits	£		1,168,500
   Credits
   Accumulated depreciation	£		7,500
   Accounts payable			111,000
   Common stock			450,000
   Retained earnings			0
   Equity adjustment			0
   Sales revenue			600,000
   Total credits	£		1,168,500

   Required: Prepare London’s Corporation Financial Statement under Current Rate Method.

2. Translation working papers;
3. Translated income statement; and
4. Translated balance sheet.

A food company has recently introduced a new line of fruit pies in 6 US cities: Atlanta, Baltimore, Chicago, Denver, St. Louis, and Fort Lauderdale. Based on the pie’s apparent success, the company is considering a nationwide launch. Before doing so, it has decided to use data collected during a two-year market test to guide it in setting prices and forecasting future demand.

            For each of the 6 markets, the firm has collected eight quarters of data for a total of 48 observations. Each observation consists of data on quantity demanded (number f pies purchased per week), price per pie, a competitor’s average price per pie, income, and population. The company has also included a time-trend variable. A value of 1 denotes the 1^st quarter observation, 2 the 2^nd quarter, and so on, up to 8 for the 8^th and last quarter.

            A company forecaster has run a regression on the data, obtaining the results displayed in the accompanying table.

C.) Other things equal, how much do we expect sales to grow (or fall) over the next year?

D.) How much accurate is the regression equation in predicting sales new quarter? Two years from now? Why might these answers differ?

E.) How confident are you about applying these test-market results to decisions concerning national pricing strategies for pies?

Caterpillar, Inc., a US corporation, has sold some heavy machinery to an Italian company for 10,000,000 euros, with the payment to be received in six months. Because this is a sizable contract for the firm and because the contract is in euros rather than dollars, as the Lead Risk Analyst in Caterpillar’s heavy machinery division, you need to make a recommendation to the Treasurer regarding how Caterpillar should hedge the risk arising from this transaction exposure. You have gathered the following information.

• The spot exchange rate is $1.1000/€ (i.e., 1 euro = 1.1000 US dollars)
• The six month forward rate is $1.1050/€
• Caterpillar’s cost of capital is 10% per annum.
• The euro 6-month borrowing rate is 4% per year (or 2% for 6 months)
• The euro 6-month lending rate is 2% per year (or 1% for 6 months)
• The US dollar 6-month borrowing rate is 5% per year (or 2.5% for 6 months)
• The US dollar 6-month lending rate is 3% per year (or 1.5% for 6 months)
• The premium on 6 month put options on the euro with strike rate $1.10 is 2.5%.

You need to compare the hedging alternatives in order to make a recommendation. To that end, you are required to compute the net receipts in dollars of each hedging alternative. The phrase “net receipts in dollars” refers to the (actual or deemed) net cash inflow in dollars in six months time.

a) Suppose that Caterpillar chooses to hedge its transaction exposure using a forward contract. Will Caterpillar sell or buy euros forward? What will be the net receipts in dollars? In other words, what is the amount Caterpillar will receive in dollars in six months time?

b) Suppose Caterpillar chooses a money market hedge. What are the transactions that the firm will need to undertake to implement this hedge, and what will be the net receipts in dollars using this hedge?

c) Suppose Caterpillar decides to hedge using a put option.

(i) Suppose that the spot rate in 6 months is $1.15 per euro. Will the option be exercised? What will be the net receipts in dollars?

(ii) Suppose that spot rate in 6 months is $1.05 per euro. Will the option be exercised? What will be the net receipts in dollars?

Ace Builders, a home building company based in the North-Eastern part of the US, has been noticing increasing demand for family- friendly housing with several amenities in dense urban centers such as New York, Boston and Philadelphia. Ace Builders realizes that their direct competitor, Beta Builders, is already meeting this growing demanding because they quickly converted, in downtown Boston, a brand new building for studio apartments into 2 and 3 bedroom apartments, which have sold out in days. Ace Builders realized that Beta Builders may have beaten them in this round of competition likely because Beta Builders:

- Was keeping a close eye on the key demographic trend of peoples shifting from urban dwellings to suburbs and exurbs

- Was keeping a close eye on the key demographic trend of peoples shifting from suburbs to exurbs to urban dwellings

- Was keeping a close eye on the key psychographic trend of peoples shifting from urban dwellings to suburbs and exurbs

- Was ignoring the key demographics trend of people shifting from urban dwelling to suburbs and exurbs

-Was keeping a close eye on the key demographic trend of people paying for suburban dwellings in exurbs and cities

General Motors Company, a major US manufacturer of cars and trucks, issues a five-year bond that pays no coupons. At the bond’s maturity the company promises to pay $100M plus an additional amount based on the price of their stock at that time. The additional amount is equal to the product of 1 million and the excess (if any) of the stock price at maturity over the current price $30. The maximum additional amount paid is $10M. Show that the bond is a combination of a regular zero coupon bond, a long position in call options with a strike price of $30, and a short position in call options with a strike price of $40.

You are the CFO of the Spade Music Company (HMC), a US-based musical instruments manufacturer. You have just made a huge sale to a British Music Festival company of GBP 2.5M worth of instruments. This money will be paid in GBP in 90 days and there is a FX risk attached to this transaction.

Given the information below, please determine what your choices are for managing this risk, be sure to consider all possible ways. Use a 360-day year basis, and determine the value on day 90 (when the payment will occur). Use the rates provided below, the bid/ask spread does not need to be considered for this problem.

Put Option Available @ 1.075 for a 1.25% premium. Minimal Acceptable Margin (USD) is 2.6 million.

Please provide all available decision choices and show calculations in details.

AnyCo is a US consumer product company enjoying broad distribution and dominant market share in its domestic market. An opportunity exists to penetrate and perhaps dominate an offshore market, PseudoLand, worth an estimated $20 million in sales per year. Domestically, however, each dollar of revenue consistently produces the following income statement (P/L):

Sales   $1.00

    Delivered Cost of Goods      .55

   Gross Profit   $ .45

   Selling Expns      .06

   General & Admin Expns       .30

   Operating Profit   $ .09

AnyCo has already begun exporting to PseudoLand and, as expected, commissions (selling expenses) are higher overseas. AnyCo’s board of directors is committed to maintaining the company’s current capital costs, and is attracted to this opportunity because it returns nearly the same operating profit (as a % of sales) as its current business in the US. However, the company’s managers want to diversify the offshore distribution strategy in order to maximize penetration. Three modes of distribution have been identified:

1. An export company has taken charge of the effort to date, but this arrangement is not exclusive.

2. Selling directly to PseudoLand consumers over the internet

3. Using a local distribution company to sell products in PseudoLand

Through research, Anyco has come to believe that the current export company can, at best, effect 50% penetration of the PseudoLand marketplace. The internet could add an additional 20%. A local distribution company would be a bit more powerful, capturing as much as 30%. Selling expenses are 7% for the export company and 4% over the internet. However, the local distributor has balked at Anyco’s standard 6% commission, and is demanding 10%. Negotiations with the local distributor look inevitable.

Determine the best alternative to a negotiated agreement (BATNA) and a reservation sales commission above which, the company would walk away without an agreement. Using not more than one typed page (single spaced) and one spread sheet, explain your findings.

* Please elaborate reasoning!

an us company has two manufacturing plants one in UAE and one in another country. Both produce the same items,eath for sale in their perspectives countries. However their productivity figures are quite different. The analyst thinks this is because the UAE plan uses more automated equipment for processing while the other uses a high percentage for labor.
1-explain how that factor can cause productivity figures to be misleading.
2-Is there another way to compare the two plants that would be more meaningful?

Consider the following rates of return: Year / Large Company Stocks / US Treasury Bill 1 3.99 % 4.59 % 2 14.16 4.94 3 19.25 3.86 4 –14.43 6.99 5 –31.92 5.30 6 37.49 6.20 a. Calculate the arithmetic average returns for large-company stocks and T-bills over this period. b. Calculate the standard deviation of the returns for large-company stocks and T-bills over this period. c-1 Calculate the observed risk premium in each year for the large-company stocks versus the T-bills. What was the arithmetic average risk premium over this period? c-2 Calculate the observed risk premium in each year for the large-company stocks versus the T-bills. What was the standard deviation of the risk premium over this period?

Use the following information to answer the next four questions.

Your business (US company) will receive a payment of 150,000 British pounds. You have decided to fully hedge your company’s foreign exchange risk with futures contracts. Each futures contract for British pounds has an initial margin of $1500 and a maintenance margin of $1100. Each futures contract has 25,000 British pounds attached. You open your position on 11/30/2018 when the futures price was $1.955 per pound. The table below shows the futures prices for the three days immediately after you opened your position.

1) Find your initial margin balance on the day you opened your position.

2) Find your ending margin balance on 12/1. Assume any deficits are eliminated to keep the position open and any excesses remain in the account.

3) Find your ending margin balance (in dollars) on 12/3.  Assume deficits are eliminated to keep the position open and excesses remain in the account. Do not use currency symbols or words when entering your response.

4) Find the total amount of variation margin that occurred from 11/30-12/3.