On May 1st, Acme Equipment, a wholly owned subsidiary of Widgets Inc. (U.S.), sold a 12 megawatt compression turbine to X-cell Company in France for elementof 2, 2000,000, payable on August 1st. Acme derived its price quote of elementof 2, 2000,000 on April 1st by dividing its normal U.S. dollar sales price of $2, 160,000 by the then current spot rate of $1.0800/elementof. By the time the order was received and booked on May 1st, the euro had strengtened to $1.1000/elementof, so the sale was in fat worth elementof 2,000,000 times $1.1000/elementof = $2, 200,000. Acme had already gained an extra $20,000 from favorable exchange rate movements. However, Acme's director of finance now wonders if the firm should hedge against a reversal of the recent trend of the euro. Four approaches were possible: i. Hedge in the forward market. The 3-month forward exchange quote was $1.1060/elementof. ii. Hedge in the money market. Acme could borrow euros from the Frankfurt branch of its U.S. bank at 8.00% per annum. iii. Do nothing. Acme could wait until the sales proceeds were received in August, hope the recent strengthening of the euro would continue, and sell the euros received for dollars in the spot market. Acme estimates the cost of equity capital to be 12% per annum. As a small firm, Acme Equipment is unable to raise funds with long-term debt. U.S. T-bills yield 3.6% per annum. a. Describe the specific steps needed to execute each approach. Explain what happens on May 1 and what happens on August 1 (90 days later). b. Calculate the result/value for following each approach. c. Draw charts to show the payout for each approach. Use the exchange rate as the x-axis and the value in U.S. dollars as the y-axis. Label important values on the chart. On May 1st, Acme Equipment, a wholly owned subsidiary of Widgets Inc. (U.S.), sold a 12 megawatt compression turbine to X-cell Company in France for elementof 2, 2000,000, payable on August 1st. Acme derived its price quote of elementof 2, 2000,000 on April 1st by dividing its normal U.S. dollar sales price of $2, 160,000 by the then current spot rate of $1.0800/elementof. By the time the order was received and booked on May 1st, the euro had strengtened to $1.1000/elementof, so the sale was in fat worth elementof 2,000,000 times $1.1000/elementof = $2, 200,000. Acme had already gained an extra $20,000 from favorable exchange rate movements. However, Acme's director of finance now wonders if the firm should hedge against a reversal of the recent trend of the euro. Four approaches were possible: i. Hedge in the forward market. The 3-month forward exchange quote was $1.1060/elementof. ii. Hedge in the money market. Acme could borrow euros from the Frankfurt branch of its U.S. bank at 8.00% per annum. iii. Do nothing. Acme could wait until the sales proceeds were received in August, hope the recent strengthening of the euro would continue, and sell the euros received for dollars in the spot market. Acme estimates the cost of equity capital to be 12% per annum. As a small firm, Acme Equipment is unable to raise funds with long-term debt. U.S. T-bills yield 3.6% per annum. a. Describe the specific steps needed to execute each approach. Explain what happens on May 1 and what happens on August 1 (90 days later). b. Calculate the result/value for following each approach. c. Draw charts to show the payout for each approach. Use the exchange rate as the x-axis and the value in U.S. dollars as the y-axis. Label important values on the chart