3. XYZ Inc. a US based company expects to receive 10 million euros in each of the next 10 years. At the same time the company needs to obtain 2 million Mexican pesos in each of the next 10 years. The euro exchange rate is presently valued at $1.48 and is expected to depreciate by 3 percent each year over time. The peso is valued at $0.11 and is expected to depreciate by 2.5 percent each year over time. Do you think that the exchange rate movements will have a favorable or unfavorable effect on XYZ Inc. Justify your answer with appropriate example.

1.         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? (2 points)

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? (3 points)

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? (2 points)

(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? (2 points)

d) Suppose that you strongly expect the euro to depreciate. In that case, which of the hedging alternatives would you recommend? Briefly justify your recommendation (2 points)

e) Suppose that you strongly expect the euro to appreciate. In that case, which of the hedging alternatives would you recommend? Briefly justify your recommendation (2 points)

f) By how much does the euro need to appreciate to make the put option at least as good an alternative (in retrospect) as the forward contract? In other words, by how much does the euro need to go up in value against the dollar in order for the net cash inflow from the put option to equal the cash inflow from the forward contract? Support your answer with calculations. (2 points)

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?

d) Suppose that you strongly expect the euro to depreciate. In that case, which of the hedging alternatives would you recommend? Briefly justify your recommendation

e) Suppose that you strongly expect the euro to appreciate. In that case, which of the hedging alternatives would you recommend? Briefly justify your recommendation

f) By how much does the euro need to appreciate to make the put option at least as good an alternative (in retrospect) as the forward contract? In other words, by how much does the euro need to go up in value against the dollar in order for the net cash inflow from the put option to equal the cash inflow from the forward contract? Support your answer with calculations.

New Assignment 7

USE US GAAP

A) Company A has the following income statement information for the years 2015-2017:

                                                2015 Income           2016 Income           2017 Income

                                                Statement as           Statement as              Statement

                                                   Reported                   Reported                   Totals     

Sales 10,000,000               12,500,000               17,000,000

Cost of Goods Sold           6,200,000                7,250,000                10,260,000

Gross Profit 3,800,000                5,250,000                6,740,000

Operating Expenses          2,100,000                2,835,000                3,219,000

Income from

   Operations 1,700,000                2,415,000                3,521,000

Non-Operating Items           (220,000)                   (171,000)                  (249,000)

Income from

   Continuing Operations 1,480,000                2,244,000                3,272,000

Income Tax Expense 370,000                     561,000                     818,000

Net Income                            1,110,000               1,683,000                2,454,000

During 2017, Company A changed its inventory method from weighted-average to FIFO. This change brought Hogan’s accounting into line with other companies in the industry and was approved by their auditor. Company A will continue to use the weighted-average method for tax purposes. Cost of Goods Sold under FIFO would have been $5,800,000 for 2015 and $6,900,000 for 2016.

For years prior to 2015, the change would have increased income from continuing operations by a total of $3,200,000. Company A is a calendar year company. Assume a tax rate of 25% for all years.

Required: Prepare in good form the complete 2017 Income Statement showing 2015 and 2016 Income Statements for comparative purposes. Additionally, prepare the retained earnings portion of the Statement of Stockholder’s equity for these comparative statements. (The retained earnings balance on January 1, 2015 was $3,654,000) Assume Company A declared and paid $100,000 of cash dividends each year 2015-2017.

Part B. ABC Co. decided on March 3, 2017 to dispose of their Widget Segment. The sale of the segment was completed on November 13, 2017. The disposal of this segment qualifies as a discontinued operation. Income Statement data for ABC for calendar years 2015-2017 are as follows:

                                                               2017                           2016                           2015   

Sales                                                  $3,000,000               $2,700,000               $2,500,000

Cost of goods sold 1,800,000                1,593,000                1,525,000

Operating expenses                          700,000                     680,000                     650,000

These amounts include the operating results for the Widget Segment through its disposal on November 13, 2017. Income Statement data for the Widget Segment separately for 2015-2017 are as follows:

                                                               2017                           2016                           2015   

Sales $450,000                   $600,000                   $700,000

Cost of goods sold 315,000                   408,000                   455,000

Operating expenses                     120,000                   150,000                   130,000

The book value of the assets and liabilities of Widget on November 13, 2017 was 4,800,000. The sales price was 6,210,000. ABC has a tax rate of 28% for 2015 & 2016 and a rate of 25% for 2017.

Additionally, ABC had 800,000 shares of common stock outstanding for the entire three-year period. There was no preferred stock outstanding during any of the years. ABC did have 300,000 stock options with an exercise price of $10 outstanding all three years. The average market price of ABC stock was $12 on 12/31/15, $15 on 12/31/16, and $20 on 12/31/17.

Required: Prepare, in good form, complete comparative Income Statements for ABC for the years 2015-2017 including required earnings per share information.

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.