Question A :
Alcoa Chemical, a US company, has sold £2 million chemicals to CPL Co. Payment is due in 180 days.
Spot rate: $1.60/£
180-day forward rate $1.56/£
180-day U.S. dollar interest rate (annualized) 3%
180-day Pound interest rate (annualized) 4%
180-day call option on pound at $1.57/£ premium $0.06 per pound
180-day put option on pound at $1.57/£ premium $0.05 per pound
(a) What is the hedged value of Alcoa's receivable using the forward market hedge?
(b) What is the hedged value of Alcoa's receivable using the money market hedge?
(c) Which of the hedging alternatives analyzed in parts (a) and (b) would you recommend to Alcoa? Why?
(d) What alternative is available to Alcoa to use currency options to hedge its receivable? What is the hedged value of Alcoa's receivable using the option hedge?
(e) Discuss and compare the costs of hedging by forward contracts and option contracts.
(Numbers should be rounded to at least 3 decimal places. Please include currency symbols $, £ in your answer)
Question B:
Mill Company is evaluating the proposed acquisition of a new milling machine. The machine's base price is $150,000, and has a terminal value of $20,000. The company's cost of capital is 8%. The project has a life-time of 3 years. The operating cash flows are as follows:
Year 1 Year 2 Year 3
1. After-tax savings $35,000 $35,000 $35,000
2. Depreciation tax savings $22,500 $25,000 $8,000
Net cash flow $57,500 $55,000 $43,000
(a) Find the net present value of this project (NPV). Should it be accepted?
Suppose Mill Company wishes to expand its operations in the UK. The exchange rate at the time of investment is £1= $1.60.
(b) Use the PPP to find the exchange rate 1 year from now, 2 years from now and 3 years from now. The inflation rate in the U.S. (?$) is 3 percent and in the UK 5 percent (?£)
(c) Find the NPV in pounds. Should Mill Company invest in the UK?
(Numbers should be rounded to at least 3 decimal places. Please include currency symbols $, £ in your answer)