Spectrum AB

Spectrum is an 100% Swedish owned affiliate of a US polymer company. It produces plastic sheets of polypropylene for use in downstream manufacturing. Due to the generic nature of its products, they have a high degree of price elasticity.

Spectrums output is sold 60% in Sweden while the remaining 40% is exported. All products are invoiced in Swedish Kronar. Spectrum employs only Swedish labor but it uses both foreign and local sources for raw materials. Its effective tax rate in Sweden is 40%. Annual depreciation on plant and equipment is SEK 900,000. Spectrum has SEK 3 million debt maturing in 3 years.

Weighted average cost of capital is 15%. All cash flows should be discounted at this rate to determine present value.

SEK, the Swedish Kronar, is experiencing weakness and analysts are convinced it will soon experience a sudden devaluation of 20%, which will bring the exchange rate USD/SEK from 4.0000 to 5.0000.

Part 1) Using the balance sheet and cash flow statement below, estimate the 3 year economic impact to Spectrum AB from the parents company perspective of a 20% devaluation. The economic impact is the sum of the next 3 years discounted cashflow changes. Make sure any balance sheet changes which affect cash flow are incorporated into your projections. For further guidance, see section 10.4 of your reader.

Base case: all variables remain the same

Scenario 2: sales and import prices rise, volume does not change, domestic raw materials are substituted for imported materials, all other costs remain the same.

You forecast that despite price elasticity, you will be able to raise product price to SEK 25 and sales volume will not change. Unfortunately, your imported price of raw materials will change. However, you have sourced a local supplier which will provide 100% domestic raw materials at a SEK price only slightly higher from before devaluation. This means that total operating expenditures will rise only 4%. Overhead expenses will not change.

Scenario 3: sales prices remain unchanged, sales volume rises and import prices rise.

Your view is that the upcoming devaluation is an opportunity for Spectrum to crush its competition. You forecast that if SEK prices remain unchanged at SEK 20, unit sales volume will rise by 50%, both domestically and abroad, after devaluation. SEK cost of local labor and locally sourced materials will stay the same, meaning that total SEK per unit operating expenditures will only increase 5.6%. Overhead expenses will not change.

Part 2) Compare the various economic impacts in a table. Which scenarios do you forecast to be most likely after devaluation? How much will this increase or decrease the economic value of Spectrum?

Part 3) List 5 steps you can take now to hedge transactional losses before devaluation occurs. Will any of these change your 3 year economic impact?

U.S. Dollars After Krona Devaluation (SKr 5 = $1) U.S. Dollars Before Krona Devaluation (SKr 4 = $1) Kronor Monetary/ Current Rate Nonmonetary $ 250,000 $1,250,000 $ 675,000 $2,500,000 $4,675,000 $ 200,000 1,000,000 540,000 2,000,000 $3,740,000 $ 200,000 1,000,000 675,000 2,500,000 $4,375,000 Assets Cash Skr 1,000,000 Accounts receivable 5,000,000 Inventory 2,700,000 Net fixed assets 10,000,000 Total assets SKr 18,700,000 Liabilities Accounts payable 2,000,000 Long-term debt 3,000,000 Equity 13,700,000 Total liabilities plus equity Skr 18,700,000 Translation gain (loss) 500,000 750,000 3,425,000 $4,675,000 400,000 600,000 2,740,000 $3,740,000 $(685,000) 400,000 600,000 3,375,000 $4,375,000 $ (50,000) FASB-52 = Statement of Financial Accounting Standards No. 52. Units (hundred thousands) Unit Price (SK) Total (SKr) 12,000,000 8,000,000 20 Domestic sales Export sales Total revenue Total operating expenditures Overhead expenses Interest on krona debt @ 10% Depreciation Net profit before tax Income tax @ 40% Profit after tax Add back depreciation Net cash flow in kronor Net cash flow in dollars (SKr 4= $1) 20,000,000 10,800,000 3,500,000 300,000 900,000 (SKT) 4,500,000 1,800,000 (Skr) 2,700,000 900,000 (SK) 3,600,000 $900,000 U.S. Dollars After Krona Devaluation (SKr 5 = $1) U.S. Dollars Before Krona Devaluation (SKr 4 = $1) Kronor Monetary/ Current Rate Nonmonetary $ 250,000 $1,250,000 $ 675,000 $2,500,000 $4,675,000 $ 200,000 1,000,000 540,000 2,000,000 $3,740,000 $ 200,000 1,000,000 675,000 2,500,000 $4,375,000 Assets Cash Skr 1,000,000 Accounts receivable 5,000,000 Inventory 2,700,000 Net fixed assets 10,000,000 Total assets SKr 18,700,000 Liabilities Accounts payable 2,000,000 Long-term debt 3,000,000 Equity 13,700,000 Total liabilities plus equity Skr 18,700,000 Translation gain (loss) 500,000 750,000 3,425,000 $4,675,000 400,000 600,000 2,740,000 $3,740,000 $(685,000) 400,000 600,000 3,375,000 $4,375,000 $ (50,000) FASB-52 = Statement of Financial Accounting Standards No. 52. Units (hundred thousands) Unit Price (SK) Total (SKr) 12,000,000 8,000,000 20 Domestic sales Export sales Total revenue Total operating expenditures Overhead expenses Interest on krona debt @ 10% Depreciation Net profit before tax Income tax @ 40% Profit after tax Add back depreciation Net cash flow in kronor Net cash flow in dollars (SKr 4= $1) 20,000,000 10,800,000 3,500,000 300,000 900,000 (SKT) 4,500,000 1,800,000 (Skr) 2,700,000 900,000 (SK) 3,600,000 $900,000