Managing economic exposure. St Paul Ltd (a UK company) does business in the United Kingdom and New Zealand. In attempting to assess its economic exposure, it compiled the following information.
a. St Paul's UK sales are somewhat affected by the value of the New Zealand dollar (NZ$), because it faces competition from New Zealand exporters. It forecasts the UK sales based on the following three exchange rate scenarios:
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Exchange rate of NZ$
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Revenue from UK business (in millions)
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NZ$ ¼ £0.32
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£100
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NZ$ ¼ 0.33
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105
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NZ$ ¼ 0.36
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110
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b. Its New Zealand dollar revenues on sales to New Zealand invoiced in New Zealand dollars are expected to be NZ$600 million.
c. Its anticipated cost of goods sold is estimated at £200 million from the purchase of UK materials and NZ$100 million from the purchase of New Zealand materials.
d. Fixed operating expenses are estimated at £30 million.
e. Variable operating expenses are approximated as 20% of total sales (after including New Zealand sales, translated to a pound amount).
f. Interest expense is estimated at £20 million on existing UK loans, and the company has no existing New Zealand loans.
Create a forecasted income statement for St Paul under each of the three exchange rate scenarios. Explain how St Paul's projected earnings before taxes are affected by possible exchange rate movements. Explain how it can restructure its operations to reduce the sensitivity of its earnings to exchange rate movements without reducing its volume of business in New Zealand.