Apple Inc.

Your Global Capital Markets Advisory team at Citigroup just finished meeting with Apple Inc. CFO, Luca Maestri, to discuss the company's strategies for managing its exposures from continuing to outsource its iPhone manufacturing to Foxconn Technology Group, a Taiwanese multinational electronics contract manufacturer, for the next ten years. The uncertainty of the increasing U.S. trade war with China and the ongoing Russia-Ukraine war with its potential impact on the China-Taiwan relationship gave the CFO a major concern about the possible effects on the company's foreign exchange exposures over the next decade.

iPhone and the numbers

Given the increasing reliance on technology-enabled products in everyday activities, Apple has become the most valuable company globally, with a market capitalization reaching over $3 trillion in early 2022. And the iPhone continued to gush impressive profits and cash flow to Apple's bottom line. Despite impacts from the pandemic and a supply crunch, the CFO informed your team that Apple capped off a milestone calendar year, recording $378.35 billion in revenue for 2021, up from $294.1 billion in 2020. This year-on-year growth is expected to continue into the foreseeable future. The gross margin percentages were 41.8% and 38.2% in 2021 and 2020. The gross margin will likely average 40% going forward.

The CFO also stated that Foxconn charges represent 40% of the iPhone cost of goods sold. And iPhone represents 50% of Apple's total historical and projected annual revenue.

Taiwanese Dollar Exchange Rate Fluctuation

Lucas Maestri's concern was ignited because on 28 September 2021, the New Taiwan Dollar fell to a fresh six-year low, closing the day at 33.2 TWD per USD. The figure represented a 2.5% depreciation over the same day of the previous month and a 9.3% depreciation over the same day of 2020. The currency's decline in value comes against a backdrop of a slumping economy and the Central Bank's decision on 24 September to cut the discount rate for the first time in six years. In addition, a slowdown in Chinathe island's largest trading partneris contributing to depreciation pressures on the currency.

Thus, the contract renewal will expose Apple to significant foreign exchange exposure unless it is hedged appropriately. Given the ongoing inflationary price increase in the U.S. and across the globe, Taiwanese prices were expected to rise 5% to 7% per year for the foreseeable future, while the U.S. inflation is currently at 7.9% (in February 2022 and could reach over 10% by year-end) but Foxconn is willing to contractually limit annual price increases to just 5% per annum.

Taiwan Historical Exchange Rate Data

	2015	2016	2017	2018	2019
Exchange Rate (vs USD)	32.83	32.45	29.67	30.58	29.91

The payments on the proposed contract will expose Apple to exchange rate risks every 3 months. The CFO needed your team's insights in approaching the matter with all the relevant data you can provide.

• Collect currency and derivative quotes on the Taiwan $/US$ spot rate into the immediate future (up to March 2023).
• Research Spot Rate Forecasts of the Taiwan $/US$ over the coming five years
• Research Forward Rates from at least three global financial institutions over the same 5-year period.
• Research Currency Options pricing for Taiwan $/US$ for different positions for the next 12 months.
• Research Money Market interest-bearing account rates in Taiwan $ denominated accounts.
• Maestri wants you to also research the importance of currency adjustment clauses in this renegotiation contract, given the uncertainty of the war and ongoing conflicts in the region.

Question:

A) How does Apple's profitability (using return on sales as the primary metric) change depending on whether the exchange rate follows (a) forecast spot rates, (b) forward rate quotes, or (c) fixed-rate baseline assumption?

B) What are the reasons for potential currency exposure? Does Apple need to subject itself to substantial exchange rate risk? Is the risk "material"? Do you think Apple should hedge?