1. Firm and currencies In 2023, 2024, and 2025, firm A produces and sells oil. Except where...
Question:
1. Firm and currencies
In 2023, 2024, and 2025, firm A produces and sells oil. Except where noted, all transactions are on December 31. For tasks 2 and 4, please assume that firm A’s functional currency is the euro (EUR).
Firm A has some transactions in United States dollars (USD) and Canadian dollars (CAD). For its forecasted financial statements, firm A translates items from USD and CAD into EUR using IAS 21.
Firm A is established as of Dec. 31, 2022. On this date, firm A receives EUR 3,000, USD 2,000, and CAD 1,200 from the issuance of shares, recognized in share capital. Other transactions on Dec. 31, 2022 are given below.
Forecasted USD:EUR exchange rates are:
December 31 | June 30 | ||||||
2022 | 2023 | 2024 | 2025 | 2026 | 2023 | 2024 | 2025 |
1:1.20 | 1:1.40 | 1:1.10 | 1:0.90 | 1:1.15 | 1:1.25 | 1:1.30 | 1:0.80 |
Forecasted CAD:EUR exchange rates are:
December 31 | ||||
2022 | 2023 | 2024 | 2025 | 2026 |
1:1.25 | 1:1.60 | 1:1.50 | 1:1.30 | 1:1.20 |
2. Sales of oil
From sales of oil, firm A receives USD. USD received from the sale of oil are held in USD for the lifetime of firm A – these USD never are converted into EUR. Forecasted barrels of sold and price per barrel are:
Barrels sold and price per barrel in 2023 – 100 and USD 80
Barrels sold and price per barrel in 2024 – 150 and USD 100
Barrels sold and price per barrel in 2025 – 300 and USD 120
In each year, 20% of oil sales are on credit. Firm A receives cash from credit sales as of Dec. 31 of the next year. Cash from credit sales likewise is received in USD and never is converted into EUR.
3. Production of oil
On Dec. 31, 2022, firm A considers whether to pay CAD 1,200 in cash for oil rig O, used to produce oil in 2023, 2024, and 2025. From this oil rig, residual value and useful life are CAD 0 and 3 years.
On December 31, 2025, firm A will dispose of this oil rig. Firm A will receive no cash from this disposal.
During each year, forecasted units produced equal forecasted units sold. For the production of oil, firm A incurs these direct materials costs, direct labor costs, and variable overhead:
Direct materials costs – from steel used to produce the barrels that the oil is contained in
Direct labor costs – from labor used to extract oil from the ground
Variable overhead – from electricity used to operate the oil rig
Firm A uses 2 kilograms (kg) of steel per barrel. As of Dec. 31 of each year, firm A purchases enough steel to produce barrels of oil for this year – e.g., on Dec. 31, 2023, firm A purchases 100 × 2 = 200 kg of steel:
Barrels produced in 2023 and kilograms per barrel – 100 and 2
For its purchases of steel, firm A pays the spot price in cash. These purchases of steel are in EUR. The forecasted spot price as of December 31, 2023, 2024, and 2025 is EUR 5, 7, and 10 per kg.
Direct labor hours per barrel and cost per direct labor hour are the same for each year – 3 labor hours per barrel, and cost of EUR 8 per labor hour.
Kilowatts (kw) of electricity per barrel and cost per kw are the same for each year – 2 kw of electricity, and cost of EUR 3 per kw.
Firm A pays cash for direct labor costs and for variable overhead on the date when these costs are incurred.
4. Supervision
To oversee the production of oil, firm A hires supervisor S. On Dec. 31, 2022, firm A pays supervisor S a signing bonus of USD 500. This signing bonus is for labor supervisor S will provide in 2023, 2024, and 2025.
In 2023, 2024, and 2025, supervisor S receives a salary of USD 600 per year. This salary is separate from the signing bonus. For this salary, in each year, USD 300 is paid on June 30. The other USD 300 is paid on Dec. 31.
Firm A hires supervisor S only if it purchases oil rig O.
5. Other costs
In 2023, 2024, and 2025, firm A rents building B. Rent expense from building B is EUR 200 per year, paid in cash as of Dec. 31 of each year.
In 2023, 2024, and 2025, firm A incurs 100 EUR per year in costs to transport oil to its place of sale. Firm A pays cash for these costs as of Dec. 31 in each year
Firm A incurs rent expense from building B and transportation costs for the oil only if it purchases oil rig O.
6. Interest and taxes
Firm A has no debt and a tax rate of 0%. As a result, firm A has no interest expense or tax expense.
7. Discounting
Firm A determines that its annual discount rate is 12%.
8. Financial statements
Firm A constructs its forecasted income statements based on variable costing. Firm A presents translation gains and losses as a separate item on the income statement, after fixed costs.
Firm A prepares its forecasted statements of cash flows under IAS 7.
For its forecasted balance sheet, firm A uses these criteria to decide whether an asset or liability is current or non-current:
• Assets
Will be recovered within 12 months – current
Will not be recovered within 12 months – non-current
• Liabilities
Will be settled within 12 months – current
Will not be settled within 12 months – non-current
Task 1
Assuming that firm A’s functional currency is the euro, please determine the net present value of cash flows from firm A’s purchase of oil rig O and decide whether firm A should purchase this oil rig.
For this task, please use the euro as firm A’s functional currency
Task 2
From the information for this case, in each year, 20% of sales are on credit.
Assume that 40% of sales are on credit, not 20% – please explain whether the net present value of firm A’s purchase of this oil rig would increase, decline, or stay the same.
Task 3
Assuming that the functional currency of firm A is the euro and that firm A purchases oil rig O, please prepare these forecasted financial statements for each year from 2022 to 2026:
forecasted income statements
forecasted statements of cash flows
forecasted balance sheets