Answered: Assume that FFG’s management has…

FINANCIAL ACCOUNTING

10th Edition

ISBN:9781259964947

Author:Libby

Publisher:Libby

Chapter1: Financial Statements And Business Decisions

Section: Chapter Questions

Problem 1Q

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Fast Foods Giant (FFG) is a fast food chain and purchases 100,000 pounds of soybean oil per month to fry French fries. FFG typically purchases soybean oil on the local spot market and the company has not entered into any forward purchase contracts for its soybean oil. FFG’s management team has prepared a business plan for the year which assumes $30.00 per pound soybean oil prices. Margins in the fast food business are fairly slim, though, so management is concerned that a significant increase in the price of oil could cause the company to miss its earnings projections. Spot soybean oil prices have been acceptable over the first six months of the year, but management is now concerned about December oil prices. On July 1, management decides it wants to use soybean oil futures contracts to manage its price risk for purchases of soybean oil in December. Assume that FFG’s management has properly documented a cash flow hedge accounting program associated with this risk management activity, and based on a valid assessment, management believes that the December CME soybean oil futures contract will be a highly effective hedge against its December soybean oil prices. The following chart provides information about soybean oil prices: Expected local cash price for December soybean oil delivery/lb CME December Soybean oil Futures price/lb. July 1 $30.50 $32.00 September 30 32.35 34.50 December 31 36.10 37.50 1. What futures transaction should FFG make? (circle one) BUY December CME futures Sell December CME futures

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