HW: Economic Exposure Example

Consider a Danish subsidiary (Bansk AS) of a US firm, Graphic Systems. Assume that Bansk AS has the following projected income statement below at the current exchange rate of $0.20/Danisk kroner (DK).

Table: Cashflows in Danisk Kroner (DK)

Total sales (2 m units @DK20/unit) DK40.0 million

Less Direct Costs (2 m units @ DK12) (DK24.0 mill)

Overhead expenses ( DK 5.1 mill)

Less Depreciation (DK 0.9 mill)

Profit before taxes (DK10.0 million

Taxes @ 50% DK 5.0 mill)

Profit after taxes DK 5.0 million

Add back depreciation DK 0.9 million

Cash flow in DK DK 5.9 million

Cashflow in $ @ $0.20/DK $ 1.18 million

Assume DK devalues to $0.15/DK.

Assume of the 2 million units, 1 million are sold at home and 1 million are exported.

Consider three scenarios:

Case (a): Sticky prices at home (same at DK20/unit but increase in export prices by 33% to DK26.67/unit.

Case (b): Due to DK devaluation, Bansk AS is able to increase its export by 100% to 2 million units from 1 million while maintaining domestic sales at 1 million. As a result of increase in production, overtime increases and unit costs increase to DK13/unit from DK12/unit. Sales price remains at DK20/unit for domestic as well as export sales.

Case (c): Demand for product is inelastic and parent company can afford to maintain dollar sale price (for both domestic and export sales) for the product at US$4/unit pr DK26.67/unit while the unit sales remain at 2 million units, half at home and half domestic.

Compute the cash-flows in dollars under each scenario?