In the U.S., firms are subject to progressive corporate tax. Consider XYZ Inc., an exporting firm,...

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In the U.S., firms are subject to progressive corporate tax. Consider XYZ Inc., an exporting firm, which expects to earn $20 million if the dollar depreciates, but only $10 million if the dollar appreciates. Assume that the dollar has an equal chance of appreciating or depreciating, and assume the following corporate tax scheme:< Corporate income tax rate = 15% for the first $15 million.< Corporate income tax rate = 40% for earnings exceeding $15 million XYZ has two ways to hedge its risky earnings: option market hedge and forward market hedge. Of course, it can also choose not to hedge at all.< a) Calculate the expected tax of XYZ under the above tax scheme when it does not hedge.< b) By hedging with options, XYZ expects to earn $17 million if the dollar depreciates, and to earn $13 million if the dollar appreciates. Calculate the expected tax of XYZ with an option market hedge.< c) By hedging with forwards, XYZ expects to earn $15 million regardless of the changes in the dollar exchange rate. Calculate the expected tax of XYZ with a forward market hedge.< d) Comment on the strategy (whether to hedge; if hedge, which way) that XYZ should adopt.< In the U.S., firms are subject to progressive corporate tax. Consider XYZ Inc., an exporting firm, which expects to earn $20 million if the dollar depreciates, but only $10 million if the dollar appreciates. Assume that the dollar has an equal chance of appreciating or depreciating, and assume the following corporate tax scheme:< Corporate income tax rate = 15% for the first $15 million.< Corporate income tax rate = 40% for earnings exceeding $15 million XYZ has two ways to hedge its risky earnings: option market hedge and forward market hedge. Of course, it can also choose not to hedge at all.< a) Calculate the expected tax of XYZ under the above tax scheme when it does not hedge.< b) By hedging with options, XYZ expects to earn $17 million if the dollar depreciates, and to earn $13 million if the dollar appreciates. Calculate the expected tax of XYZ with an option market hedge.< c) By hedging with forwards, XYZ expects to earn $15 million regardless of the changes in the dollar exchange rate. Calculate the expected tax of XYZ with a forward market hedge.< d) Comment on the strategy (whether to hedge; if hedge, which way) that XYZ should adopt.<

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Answer a When XYZ Inc does not hedge the expected earnings are calculated as Expected Earnings Earni... View the full answer