Question
Cash Flow Hedge - Forward Contract (3rd part) Knock On Wood (KOW) uses lumber to produce its wooden furniture. KOW anticipates it will need to
Cash Flow Hedge - Forward Contract (3rd part)
Knock On Wood (KOW) uses lumber to produce its wooden furniture. KOW anticipates it will need to purchase 1,000,000 board feet of lumber in July 2022 to make enough furniture to meet its fourth quarter sales demand. However, if the price of lumber increases, the cost to produce the furniture will increase and, in turn, lower KOWs profit margins. To hedge against the risk of rising lumber prices, on March 1, 2022, KOW enters into a forward contract with a third-party intermediary to buy 1,000,000 board feet of lumber at the current spot price of $350 per 1,000 board feet. It designates the contract as a cash flow hedge of the anticipated lumber purchase because the hedged risk is attributable to the volatility in lumber prices. The price in the contract expires on July 31, 2022 (but could be settled at any day in July), and the contract will settle by an exchange of cash with the intermediary based on the spot price on the settlement date. The spot price of lumber was $342 on 3/31/2022, and $374 on 6/30/2022. On 7/1/2022 KOW purchased 1,000,000 board feet of lumber and settled the forward contract (the price of lumber was still $374 per 1,000 board feet). KOW used the purchased lumber to manufacture furniture during the following 3 months. KOW sells its furniture during the fourth quarter of 2022 for $850,000, and the total value of the inventory, which includes the cost of the lumber purchase made on July 1, 2022, is $570,000.
Required: What is the cash settlement amount on 7/1/2022? If KOW receives cash, enter a positive number, and if KOW has to pay cash, enter a negative number by adding a minus sign before the number. In both cases, do not write the thousand comma or a dollar sign (so, for example, for $25,000 write 25000).
*Please show all work so I may better understand the problem (Excel is preferred). Thanks!
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