Fin4802

Assignment 02

QUESTION 1

  | Original Impact of Possible Exchange Rates on Cash Flows of Madison Co. (in Millions) |   |   |   |

  | Exchange rates scenarios |   |   |   |

  |   | C$ million |   |   |

  | Item | Scenario 1 | Scenario 2 | Scenario 3 |

  | Value Canadian dollar | C$1=$0.75 | C$1=$0.80 | C$1=$0.85 |

  | sales |   |   |   |

1 | U.S sales | 320 | 320 | 320 |

2 | Canadian sales (C$4million) | 3 | 3.2 | 3.4 |

3 | Total Sales in U.S.$ | 323 | 323.2 | 323.4 |

  | Less Cost of goods sold |   |   |   |

4 | U.S Costs | 50 | 50 | 50 |

5 | Canadian Costs (C$200) | 150 | 150 | 150 |

6 | Total costs in U.S $ | 200 | 210 | 220 |

7 | Gross profit | 123 | 113.2 | 103.4 |

  | Less Operating expenses: |   |   |   |

8 | U.S:Fixed | 60 | 60 | 60 |

9 | Less :U.S :Variable costs | 0 | 0 | 0 |

10 | Total | 60 | 60 | 60 |

11 | Earnings Before Interest &Tax (EBIT) | 63 | 53.2 | 43.4 |

  | Less :Interest Expenses |   |   |   |

12 | U.S Interest expenses | 3 | 3 | 3 |

13 | Canadian interest expenses (C$10= | 7.5 | 8 | 8.5 |

14 | Total interest expenses in U.S $ | 10.5 | 11 | 11.5 |

15 | Cash flows in U.S $ (EBT) | 52.5 | 42.2 | 31.9 |

  |   |   |   |   |

Summary

-The above scenario enables Madison to assess how its cash flows before taxes will be affected by different exchange rate movements.

-A stronger Canadian dollar increases Madison’s dollar revenue earned from Canadian sales, increases cost of materials purchased from Canada and the dollar amount needed to pay interest on loans from Canadian banks.

-If the Canadian dollar strengthens consistently over the long run, Madison’s expenses likely will rise at a higher rate than its U.S. dollar revenue.

-Consequently, it may wish to institute some policies to ensure that movements of the Canadian dollar will have a more balanced impact on its revenue and expenses.

-Now that Madison has assessed its exposure, it recognizes that it can reduce this exposure by...