Answered step by step
Verified Expert Solution
Link Copied!

Question

1 Approved Answer

A trucking company quotes delivery charges for up to 1 year in advance. Diesel fuel is a large component of its operating costs. They are

A trucking company quotes delivery charges for up to 1 year in advance. Diesel fuel is a large component of its operating costs. They are expected to purchase 5,000,000 gallons of fuel in one year. Assume all fuel is purchased in exactly one year and they estimate costs could be as low as $2.25 and as high as $3.50 per gallon. The company would like to hedge its fuel expenses. The one year forward price is $2.70 per gallon. A call option with a strike price of $2.70 is selling for $.20 per gallon. The corporate tax rate is 25%.

a. Suppose they enter into a forward contract on all 5,000,000 gallons. What is the hedged, after tax, total cost of fuel (including derivative cashflows) if fuel is selling for $2.25 or $3.50? Show both values.

b. Suppose they enter into a call option contract on all 5,000,000 gallons. What is the hedged, after tax, total cost of fuel (including derivative cashflows) if fuel is selling for $2.25 or $3.50? Show both values.

c. Suppose they enter into a call option contract on 1,000,000 gallons, a forward contract on 3,000,000 gallons, and do not hedge 1,000,000 gallons. What is the hedged, after tax, total cost of fuel (including derivative cashflows) if fuel is selling for $2.25 or $3.50? Show both values.

image text in transcribed

(20 points) A trucking company quotes delivery charges for up to 1 year in advance. Diesel fuel is a large component of its operating costs. They are expected to purchase 5,000,000 gallons of fuel in one year. Assume all fuel is purchased in exactly one year and they estimate costs could be as low as $2.25 and as high as $3.50 per gallon. The company would like to hedge its fuel expenses. The one year forward price is $2.70 per gallon. A call option with a strike price of $2.70 is selling for S.20 per gallon. The corporate tax rate is 25%. a. Suppose they enter into a forward contract on all 5,000,000 gallons. What is the hedged, after tax, total cost of fuel (including derivative cashflows) if fuel is selling for $2.25 or $3.50? Show both values. 7 8 9 10 b. Suppose they enter into a call option contract on all 5,000,000 gallons. What is the hedged, after tax, total cost of fuel (including derivative cashflows) if fuel is selling for $2.25 or $3.50? Show both values. 12 c. Suppose they enter into a call option contract on 1,000,000 gallons, a forward contract on 3,000,000 gallons, and do not hedge 1,000,000 gallons. What is the hedged, after tax, total cost of fuel (including derivative cashflows) if fuel is selling for $2.25 or $3.50? Show both values. 13 14 15 Gallons T=1 16 Forward Price and Option Strike Price T 17 $2.70 Strike Price Call Option Price/Gall 18 Tax Rate 5,000,000 $2.70 $0.20 25% 19 20 a. Forward b. Option c. Forward and Call 21 Low Price of Fuel/Gallon To1 22 High Price of Fuel/Gallon T=1 Fuel Price I $2.25? $3.50 ? 25 (20 points) A trucking company quotes delivery charges for up to 1 year in advance. Diesel fuel is a large component of its operating costs. They are expected to purchase 5,000,000 gallons of fuel in one year. Assume all fuel is purchased in exactly one year and they estimate costs could be as low as $2.25 and as high as $3.50 per gallon. The company would like to hedge its fuel expenses. The one year forward price is $2.70 per gallon. A call option with a strike price of $2.70 is selling for S.20 per gallon. The corporate tax rate is 25%. a. Suppose they enter into a forward contract on all 5,000,000 gallons. What is the hedged, after tax, total cost of fuel (including derivative cashflows) if fuel is selling for $2.25 or $3.50? Show both values. 7 8 9 10 b. Suppose they enter into a call option contract on all 5,000,000 gallons. What is the hedged, after tax, total cost of fuel (including derivative cashflows) if fuel is selling for $2.25 or $3.50? Show both values. 12 c. Suppose they enter into a call option contract on 1,000,000 gallons, a forward contract on 3,000,000 gallons, and do not hedge 1,000,000 gallons. What is the hedged, after tax, total cost of fuel (including derivative cashflows) if fuel is selling for $2.25 or $3.50? Show both values. 13 14 15 Gallons T=1 16 Forward Price and Option Strike Price T 17 $2.70 Strike Price Call Option Price/Gall 18 Tax Rate 5,000,000 $2.70 $0.20 25% 19 20 a. Forward b. Option c. Forward and Call 21 Low Price of Fuel/Gallon To1 22 High Price of Fuel/Gallon T=1 Fuel Price I $2.25? $3.50 ? 25

Step by Step Solution

There are 3 Steps involved in it

Step: 1

blur-text-image

Get Instant Access to Expert-Tailored Solutions

See step-by-step solutions with expert insights and AI powered tools for academic success

Step: 2

blur-text-image

Step: 3

blur-text-image

Ace Your Homework with AI

Get the answers you need in no time with our AI-driven, step-by-step assistance

Get Started

Recommended Textbook for

International Finance

Authors: Keith Pilbeam

4th Edition

0230362893, 978-0230362895

More Books

Students also viewed these Finance questions