A US firm does business in Australia. In attempting to assess its economic exposure, it compiled the following information: Its U.S. sales are somewhat affected by the value of the Australian dollar (AU$), because it faces competition from Australian exporters. It forecasts the U.S. sales based on the following three exchange rate scenarios: Revenue from U.S. Business Exchange Rate of AU$ (in millions) AU$ = $.70 $100 AU$ = $.75 105 AU$ = $.80 110 Its Australian dollar revenues from sales in Australia invoiced in Australia dollars are expected to be AU$600 million Its anticipated cost of materials is estimated at $200 million from the purchase of U.S. materials and AU$100 million from the purchase of Australia materials Fixed operating expenses are estimated at $30 million Variable operating expenses are estimated at 20% of total sales (after including Australian sales, translated to a dollar amount) Interest expense is estimated at $20 million on existing U.S. loans, and the company has no existing Australian loans. Forecast net cash flows for this US firm under each of the three exchange rate scenarios. Explain how its projected net cash flows are affected by possible exchange rate movements. Explain how it can restructure its operations to reduce the sensitivity of its net cash flows to exchange rate movements without reducing its volume of business in Australia.

International Financial Management

14th Edition

ISBN:9780357130698

Author:Madura

Publisher:Madura

Chapter12: Managing Economic Exposure And Translation Exposure

Section: Chapter Questions

Problem 11QA

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A US firm does business in Australia. In attempting to assess its economic exposure, it compiled the following information:
Its U.S. sales are somewhat affected by the value of the Australian dollar (AU$), because it faces competition from Australian exporters. It forecasts the U.S. sales based on the following three exchange rate scenarios:

Revenue from U.S. Business

Exchange Rate of AU$ (in millions)

AU$ = $.70 $100

AU$ = $.75 105

AU$ = $.80 110

Its Australian dollar revenues from sales in Australia invoiced in Australia dollars are expected to be AU$600 million
Its anticipated cost of materials is estimated at $200 million from the purchase of U.S. materials and AU$100 million from the purchase of Australia materials
Fixed operating expenses are estimated at $30 million
Variable operating expenses are estimated at 20% of total sales (after including Australian sales, translated to a dollar amount)
Interest expense is estimated at $20 million on existing U.S. loans, and the company has no existing Australian loans.

Forecast net cash flows for this US firm under each of the three exchange rate scenarios.
Explain how its projected net cash flows are affected by possible exchange rate movements.
Explain how it can restructure its operations to reduce the sensitivity of its net cash flows to exchange rate movements without reducing its volume of business in Australia.

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