(Hedging with forwardcontracts) The Specialty Chemical Company operates a crude oil refinery located in NewIberia, Louisiana. The company refines crude oil and sells theby-products to companies that make plastic bottles and jugs. The firm is currently planning for its refining needs for one year hence. Specifically, thefirm's analysts estimate that Specialty will need to purchase 1 million barrels of crude oil at the end of the current year to provide the feed stock for its refining needs for the coming year. The 1 million barrels of crude will be converted intoby-products at an average cost of $10 per barrel that Specialty expects to sell for $175 million, or $175 per barrel of crude used. The current spot price of oil is

$120 per barrel and Specialty has been offered a forward contract by its investment banker to purchase the needed oil for a delivery price in one year of $125 per barrel.

a. Ignoringtaxes, what willSpecialty's profits be if oil prices in one year are as low as

$105 or as high as $145 assuming that the firm does not enter into the forwardcontract?

b. If the firm were to enter into the forwardcontract, demonstrate how this would effectively lock in thefirm's cost of fueltoday, thus hedging the risk of fluctuating crude oil prices on thefirm's profits for the next year.