A Midwest food processor forecasts purchasing 300,000 pounds of soybean oil in May. On February 20, the company acquires an option to buy 300,000 pounds of soybean oil in May at a strike price of $1.60 per pound. Information regarding spot prices and option values at selected dates is as follows: February 20 February 28 March 31 April 20 Spot price per pound. Fair value of option $ 1.61 3,800 $ 1.59 1,200 $ 1.62 6,800 $ 1.64 12,500 The company settled the option on April 20 and purchased 300,000 pounds of soybean oil on May 3 at a spot price of $1.63 per pound. During May, the soybean oil was used to produce food. One-half of the resulting food was sold in June. The change in the option’s time value is excluded from the assessment of hedge effectiveness.1. Prepare all necessary journal entries through June to reflect the above activity. 2. What would the effect on earnings have been had the forecasted purchase not been hedged? Assume that half of the food was sold for $300,000.
A Midwest food processor
| February 20 | February 28 | March 31 | April 20 | |
|
Spot price per pound. Fair value of option |
$ 1.61 3,800 |
$ 1.59 1,200 |
$ 1.62 6,800 |
$ 1.64 12,500 |
The company settled the option on April 20 and purchased 300,000 pounds of soybean oil on May 3 at a spot price of $1.63 per pound. During May, the soybean oil was used to produce food. One-half of the resulting food was sold in June. The change in the option’s time value is excluded from the assessment of hedge effectiveness.
1. Prepare all necessary
2. What would the effect on earnings have been had the forecasted purchase not been hedged? Assume that half of the food was sold for $300,000.
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