Economic exposure depends on whether a new exchange rate causes unexpected changes in sales volume, sales price or operating costs, which in turn can affect the future cash flow of the firm. As a result of economic exposure, a firm’s competitiveness is at stake. It is quite challenging to measure economic exposure. The firm must accurately estimate cash flows and the exchange rates, as transaction exposure has the power to alter future cash flows while fluctuation of the currency exchange rates occurs. When a foreign subsidiary gets positive cash flows after it corrects for the currency exchange rates, the subsidiary’s net transaction exposure is low. As we recognize that predominantly economic exposure can be handled by assessing revenue and expenses sensitivity to variations of exchange rate circumstance. To realize this, nevertheless, the firm ought to first identify how its revenue and expenses are affected by variations of exchange rate which sequentially will impinge on the firm’s potential cash flow. For some firms, revenue is considered as more vulnerable. These firms are highly concerned that their home currency will appreciate against foreign currencies because the adverse effects on revenue will greater than offset the positive effects on expenses. On the other hand, firms whose expenses are more susceptible to exchange rates than their revenue are most concerned that their home currency will depreciate against foreign currencies. When firms lessen their economic exposure, they reduce not only these adverse effects but also the positive effects if the home currency value changes in the opposite path. After understanding the evaluation of economic exposure from numerous perspectives, you are required to answer all the questions.

Lawrence Co. manages business in the United States and New Zealand. In endeavoring to evaluate its economic exposure, it gathered the following information.

i. Lawrence’s U.S. sales are marginally changed by the New Zealand dollar (NZ$) value, attributable to facing rivalry from New Zealand exporters. It values the U.S. sales according to the following three different exchange rate circumstances:

Revenue from U.S. Business

Exchange Rate of NZ$ (in millions)

NZ$ = $.48 $100

NZ$ = .50 105

NZ$ = .54 110

ii. Lawrence Co. revenues in New Zealand dollars are anticipated to be NZ$600 million.

iii. Cost of go ods sold is anticipated at $60 million from the U.S. materials purchase and NZ$100 million from the New Zealand materials purchase.

iv. Fixed operating expenses are estimated at $30 million.

v. Variable operating expenses are anticipated at 20 percent of total sales (after incorporating New Zealand sales, translated to a dollar amount).

vi. Interest expense is anticipated at $20 million on current U.S. loans, and the company has no existing New Zealand loans.

Questions:

1. Generate a projected Lawrence Co. income statement under each of the three different exchange rate circumstances. (9 marks)

Also answer the following questions based on the rubric. (16 marks)

2. Discuss in detail on how Lawrence’s projected earnings before taxes are affected by the crucial of exchange rate forecasting. Justify your opinions with supporting evidence as well as appropriate example.

3. Explain on the approaches that Lawrence Co. be able to restruc­ture its operations to curtail the sensitivity of earnings to the level of exchange rate movements without reducing its volume of business in New Zealand.

Answer rating: 100% (QA)

Economic exposure depends on whether a new exchange rate causes unexpected changes in sales volume sales price or operating costs which in turn can af... View the full answer