The U.K. based auto manufacturing company with a pro forma statement analysis has estimated the dependence of various cash-flow elements, in millions of £, for next year to the two main risk factors that it faces, x1 the £/$ exchange rate and x2 the GBP Libor in percentage points: Sales = 95 + 720x1−640x12+ 20x2, Operating costs = 240 + 10x2 Interest payments = 30 + 20x2 Taxation is 25% on profits and 10% (tax credit) on losses. The GBP Libor is expected to be1% and the exchange rate is expected to stay at £ 0.5/$. (a) What risk factors does the company face? (b) What are the exposures of the before tax and after tax earnings to the two risk factors? (c) What are the relevant exposures for hedging earnings? before tax exposures or after tax exposures?
1.
The U.K. based auto manufacturing company with a pro forma statement analysis has estimated the dependence of various cash-flow elements, in millions of £, for next year to the two main risk factors that it faces, x1 the £/$ exchange rate and x2 the GBP Libor in percentage points:
Sales = 95 + 720x1−640x12+ 20x2,
Operating costs = 240 + 10x2
Interest payments = 30 + 20x2
(a) What risk factors does the company face?
(b) What are the exposures of the before tax and after tax earnings to the two risk factors?
(c) What are the relevant exposures for hedging earnings? before tax exposures or after tax exposures?
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