Palmerston plc operates in both the United Kingdom and Germany. In attempting to assess its economic exposure, it compiles the following data:

UK sales are influenced by the euro’s value as it faces competition from German suppliers. It forecasts annual UK sales based on three possible scenarios:

Euro: sterling exchange rate Revenue from UK business 1.65:1 1.60:1 1.55:1

£200m

£215m

£220m Revenues from sales made in Germany are expected to be £120m p.a.

Expected cost of goods sold is £120m p.a. from UK materials purchases, and €200m from purchases in Germany.

Estimated cash fixed operating expenses are £50m p.a.

Variable operating expenses are estimated at 20 per cent of total sales value (including German sales translated into sterling).

Palmerston is financed entirely by equity and shareholders require a return of 15 per cent p.a.

Required

(i) Construct a forecast cash flow statement for Palmerston under each scenario.

(ii) Value Palmerston’s equity under each scenario, assuming a 10-year operating time horizon. Ignore terminal values.

(iii) Suggest how Palmerston might restructure its operations to lower its sensitivity to exchange rate movements.

Ignore taxation.