LUFTHANSA: TO HEDGE OR NOT TO HEDGE
1. If the DM/US$ exchange rate were 2.4DM/US$ in January 1986, what would be the all in cost of the aircraft purchase under each alternative? What would be the all in cost of the aircraft purchase under each alternative if the exchange rate were 3.4DM/US$? Consider both fully hedging the cost and hedging exactly one half of the cost (why may you only want to hedge part of the purchase price?).
1. Do nothing and wait and see what the exchange rate is like in January 1986.
500,000,000 USD x 2.4DM/USD = 1,200,000,000 DM
The cost of the aircraft purchase will be 1200 million DM.
2. Cover the purchase price using forward contracts.
If the company use forward contracts they have the
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If the company use forward contracts they have the obligation to perform, i.e. they have to buy the amount they have agreed upon in one year for the forward rate of 3.20 DM/USD.
If they fully hedging the cost the all in cost of the aircraft purchase will be:
500,000,000 USD x 3.2DM/USD = 1,600,000,000 DM
The cost of the aircraft purchase will be 1600 million DM.
If they choose to hedging exactly one half of the cost the all in cost of the aircraft purchase will be:
(250,000,000 USD x 3.4DM/USD) + (250,000,000 USD x 3.2DM/USD) = 1,650,000,000 DM
The cost of the aircraft purchase will be 1650 million DM.
3. Cover the cost using foreign currency put options
A put option gives Lufthansa the right to sell the DM at 3.20 DM/USD in one year. Even if they don’t exercise the option they have to pay the 6 % premium. The DM has depreciated in relation to the USD and therefore the option is in-the-money and Lufthansa will use the option.
If they fully hedging the cost the all in cost of the aircraft purchase will be:
500,000,000 USD x 3.2 DM/USD x 1.06 = 1696,000,000 DM
The cost of the aircraft purchase will be 1696 million DM.
If they choose to hedging exactly one half of the cost the all in cost of the aircraft purchase will be:
(250,000,000 USD x 3.4DM/USD) + (250,000,000 USD x 3.2DM/USD x 1.06) = 1,698,000,000 DM
The cost of the aircraft purchase will be 1698 million DM.
4. Borrow DM to buy USD
When the discount rate increases from 15% to 40%, the company faces a 37.3% drop in its total value. The loss will be $5,609,132. the largest difference rate comes from the silver segment. Firstly, the silver segment has the most significant amount of customers. The requirement of being a silver customer is small ( fly with the Northern Aero at least one time). Secondly, each year some of the customers will degrade from the platinum or gold segment to the silver segment. Due to the
3- As we can see the company would loss 0.52 cent per 1 kg if it decides to sell at 6.85 price and allocates the fixed expenses at 1.20 per 1 kg.
14. If 11,000 units are produced, what are the total amounts of direct and indirect manufacturing costs incurred to support this level of production?
2. What is the total cost? How much of the total cost are labor costs? Capital costs?
Springfield Express has an opportunity to obtain a new route that would be traveled 20 times per month. The company believes it can sell seats at $ 175 on the route, but the load factor would be only 60 percent. Fixed cost would increase by $ 250,000 per month for additional personnel, additional passenger train cars, maintenance, and so on. Variable cost per passenger would remain at $ 70.
Estimates of fixed costs are reasonably straightforward and are given in the case (p.280), a total of $250,000 ($160,000+$90,000).
The amount of extra sales that would be required to cover this cost of 300,000 would be
managed effectively in one way or another, that is $1.8 billion in merchandise. If half of these customers choose
On the other hand, the peso devaluation will not have that much of a positive effect on Farmington (Antilles) N.V. as the peso depreciates relative to the USD. The result is the subsidiary being negatively impacted as the USD/peso exchange rate is rising, as they convert revenue earned in pesos to USD to deposit into U.S. bank accounts. This facility had almost 4 million MXN receivables at the end of the year. The 1994 average exchange rate is 3.5 MXN/USD, where these 4 million MXNs would equate to approximately 1.14 million USD. When the exchange rate values the devalued peso at 5.0 MXN/USD, these 4 million MXNs are only equal to 0.80 million USDs, showing a loss of more than 300,000 USDs. When the exchange rate changes from 4.0 to 5.0 MXN/USD, we can see the loss the company would experience, and thus the negative impact on this facility.
The 50% premium can be explained by the valuation of the firm based purely on its projected future cash flows and assumed growth rate (value = $391.58 million) plus the added value that the ITS can provide (value = $114.2 million) when the leveraged buyout is completed. There are two components to the ITS or income tax shield –
To calculate the cost of debt and equity for this project, we combined the risk-free rate with a risk premium based on the market risk premium and the riskiness of Southwest Airlines.
i) Given that Dozier industries does nothing to hedge this risk, assuming that spot exchange rate remains the same as on Jan 14,1986 levels,
1. There are a few trends in the US airline industry. One is consolidation, wherein existing players merge in an attempt to lower their costs and generate operating synergies. The most recent major merger was the United Continental merger, which is still an ongoing affair, but has created the largest airline in the United States by market share (Martin, 2012). Another trend is towards low-cost carriers. In the US, Southwest has been a long-running success and JetBlue a strong new competitor, but in other countries this business model has proven exceptionally successful. The third major trend is the upward trend in jet fuel prices, and the increasing importance that this puts on hedging fuel prices and capacity management (Hinton, 2011).
Thus the WAVG Cost of Debt (including L/T debt and preferred stock) = rd = 8.633%
* Refer sheet “100% Options” of the attached excel. It shows the Cost that would be incurred with 100% hedge using Options for different scenarios.