AvantiMedia is the wholly owned Italian affiliate of ABC, a U.S. based multinational firm.
AvantiMedia produces Projector in Italy from Italian materials and labor. Forty Percent of production is sold within Italy and sixty percent is exported to London. All export sales are invoiced in foreign currencies and export prices are fixed in the currency of the importing country. The corporate income tax rate in Italy is 35%.
The Current exchange rates are as follow: ₤.58/$; €0.82/$.
The December 31, 2011, balance sheet is as follows.
AvantiMedia, Balance Sheet, December 31, 2011
Cash 1,500¬,000 Accounts payable 900,000
Accounts receiv¬able 3,100¬,000 Short-term bank ¬loan
(due from London & Note payable 1,800,000
Inventory 2,500¬,000 Long-term debt 1,900¬,000
Loan(3-years) from U.S.
Loan(3-years) from London
Bank (I=8%) ₤350,000
Net plant and Common stock 1,100¬,000
equipment 5,800¬,000 Retained earnings 7,200¬,000
Total Assets €12,900¬,000 Total Liabilities €12,900¬,000
AvantiMedia Expected Income and Cash Flow Statement (No Deval-uation),Dec. 31 2012
Domestic Sales (450,000 units @ €11.8/unit) 5,310,000
Export Sales (650,000 [email protected] €11.8/unit) 7,670,000
Direct costs (1,000,000 units @ €5.4/¬unit) 5,400,000
Cash operating expenses (fixed) 1,250,000
Profit before Interest and tax €5,990,000
Pre-tax profit €5,812,640
Income tax expense (35%) 2,034,424
Profit after tax €3,778,216
add back depreciation 340,000
Cash flow from operations in Italy €4,118,216
1- AvantiMedia’s Accounting Exposure:
Assume that on June 21, 2012, the Euro unex¬pectedly depreciated by 10% to all foreign currencies.
T¬ranslate the balance sheet into dollars, using the current rate method and the monetary-non-monetary method assuming that:
Plant and equipment, long-term debt, and common stock were entered on books at a time in the past when the exchange rate was €1.10/$. Inventory was purchased or manufactured during the prior quarter when the average exchange rate was €0.88/$.
2- AvantiMedia’s Economic Exposure:
Assume that on June 21, 2012, before any commercial activity begins, the Euro unexpectedly drops 10% to all foreign currencies.
To illustrate the effect of post-devaluation consider the following scenario on AvantiMedia’s economic exposure:
a. Export volume increased by 10% because Italian-Projectors are now cheaper in countries whose currencies have not weakened and sales volume within Italy is not changed.
b. The Euro sales price is raised by 10% and foreign sales price is not changed.
c. Direct costs increased by 10%.
To calculate the net change in present value under this scenario, assume a discount rate of 15% and a Two-year time horizon for any change in cash flow induced by the change in the Euro/dollar exchange rate.
3- ABC Paris Bid:
You have been asked by ABC to help determine a bid for installation of a large Projector production facility in Paris Franc. The bid, which consists of all Costs and Profit had to be specified entirely in term of Euro and is to be submitted on June 20, 2012. The client will announce the awarding decision on July 20 and the Euro payment will be received in 90 days (October 20).
ABC expects the projects to cost $1,000,000 in the U.S., £100,000 British pound for importing material from England and an addition 250,000 Euro in Paris. Actual payments for all costs need only be made on October 20. ABC will charge a 10% Profit Margin Markup on all its costs.
The following information on June 20, 2012 is to be used in answering the following questions.
U.S. 90-120 days borrowing rate = 8%
U.S. 90-120 days deposit rate = 7%
Euro 90-120 days borrowing rate = 6.5%
Euro 90-120 days deposit rate = 5.5%
Pound 90-120 days borrowing rate = 9%
Pound 90-120 days deposit rate = 8.5%
Pound spot quote = £.58/$
Pound 3-4 month Forward quote = $1.50/£
Euro spot quote = €0.82/$
Euro 3-4 month Forward quote = $1.10/€
Options strike price Call Put
3-4 month $1.05/€ $.015/€ $.012/€
3-4 month $1.45/£ $.025/£ $.02/£
Options contracts are over the counter and can be purchase for any size. Assume the transaction costs for options and forward contracts are zero.
Your task is to construct the appropriate hedges and recommend of a Euro amount to place as the bid that would guarantee the required 25% profit margin.
Please answer the following questions:
1. How much of the revenue is exposed?
2. What is the amount of bid using Borrowing and Lending?
3. What is the amount of bid using Forward contract?
For Extra Credit answer the following question:
What is the amount of bid using Options contract?
Present your suggestions clearly and make sure you describe the outcomes under all the contingencies.