Attached is Case 2. It examines the same topics in hedging that we covered in the second half of Chapter 6.

One of the requirements of the case is a hedge of an accounts receivable and the other is a hedge of an accounts payable. One is designated as a cash flow hedge and the other as a fair value hedge.

Part A

The Louisville Slugger Company is a U.S.-based manufacturer and exporter of wood baseball bats. On November 1, Year 1, Louisville sold and shipped baseball bats to an overseas customer for a price totaling 600,000 Foreign Currency Units (FCUs). Payment is to be received on April 30, Year 2.

The Treasurer is concerned that the FCU will weaken during this period. Accordingly, on the date of sale, Louisville entered into a six-month forward contract with TD Bank to sell 600,000 FCUs. The forward contract is properly designated as a cash flow hedge of a foreign currency receivable. Louisville's incremental borrowing rate is 12%. The present value factor for four-months at a borrowing rate of 12 percent (1 percent per month) is .9610. Relevant exchange rates are as follows:

Spot Forward Rate

Date Rate (to April 30, Year 2)

November 1, Year 1. . . . . . . . . . . . . . $0.23 $0.22

December 31, Year 1. . . . . . . . . . . . . . 0.20 0.18

April 30, Year 2. . . . . . . . . . . . . . . . . . 0.19 0.19

Required: 50 Points

As discussed in our lectures, the company is required to formally document the hedging transaction at the time the forward contract is entered into. In general, what information is to be included in order to satisfy the hedge documentation requirements?

Prepare all necessary journal entries to account for the sale and foreign currency forward contract. Assume that Louisville closes the books and prepares financial statements on December 31, Year 1.

Where appropriate, round to 2 decimal points.

Based upon your work in No. 2 above, what is the impact on net income for each year, and in total, due to the foreign currency aspects of this transaction?

Note:

Submit your work in a Word document or Excel only. Hand-written solutions or attachments will not be accepted. Where appropriate, show your calculations to ensure partial credit.

This is not a group case. The work submitted must be your own.

Part B

On November 1, Year 1, the Louisville Slugger Company placed an order with a Canadian company to purchase a particular grade of lumber for its quality line of baseball bats for 300,000 Canadian Dollars (CAD). Relevant exchange rates are as follows:

Spot Forward Rate

Date Rate (to January 30, Year 2)

November 1, Year 1. . . . . . . . . . . . . . $1.1584 $1.1576

December 31, Year 1. . . . . . . . . . . . . . 1.2597 1.2591

January 30, Year 2. . . . . . . . . . . . . . . . 1.2456 1.2456

Louisville closes its books and prepares financial statements on December 31, Year 1.

Required: 50 Points

Assume the lumber was received on November 1, Year 1 and Louisville pays the supplier on January 30, Year 2. On November 1, Louisville entered into a three-month forward contract to purchase CAD 300,000. The forward contract is properly designated as a fair value hedge of a foreign currency payable. Louisville's incremental borrowing rate is 12%. The present value factor for one month at an incremental borrowing rate of 12% is .99010. Prepare journal entries to account for the purchase and foreign currency forward contract. Where appropriate, round to 2 decimal points.

2. Based upon your work in No. 1 above, what is the impact on net income for each year, and in total, due to the foreign currency aspects of this transaction?