Question

BASE CASE	CHANGE SCENARIO 1	CHANGE SCENARIO 2
United States	500,000	500,000	500,000
Canada	500,000	550,000	400,000
Mexico	300,000	330,000	240,000
COST OF GOODS SOLD	1,300,000	1,380,000	1,140,000
Price paid per gallon	$1.30	$1.38	$1.14
Selling price per gallon (USD)	$1.50	$1.55	$1.20
Revenue	$1,500,000	$1,550,000	$1,220,000
Cost of goods sold	(1,300,000)	(1,380,000)	(1,140,000)
Gross profit	200,000	170,000	80,000
SG&A	(50,000)	(50,000)	(50,000)
Operating profit	150,000	120,000	30,000
Interest expense	(80,000)	(80,000)	(60,000)
Pre-tax income	70,000	40,000	(30,000)
Tax	(28,000)	(16,000)	12,000
Net Income	$42,000	$24,000	($18,000)
Gross margin	13.3%	11.0%	6.6%
Operating margin	10.0%	7.7%	2.6%
Net margin	2.8%	1.5%	Loss

Use this table above for both scenarios.

Scenario 1: New Holstein Trading Company ("NHTW") was set up after all the cows in Wisconsin got ticked off at the farmers for some reason and went to South Dakota. ? Why, I have no idea. NHTW purchases 1 million gallons of milk per year. "NHTW" has borrowed $1,000,000 at 8% interest to set up operations and is sourcing milk from other parts of the United States, Canada and Mexico. Tax rate is 40%. It was all working until the U.S. dollar (USD) fell by 10% against the Canadian dollar ($CAD) and the Mexican Peso (MXN), raising costs when translated into USD. At the same time the selling price per gallon rose by $0.05 to $1.55 per gallon. Which of the following risks were reflected in this scenario?

A. Commodity price risk

B. Currency exchange rate risk

C. Both options provided.

D. Neither A nor B.

Scenario 2: The U.S. dollar rises 20%, lowering imported commodity costs but but then the cows come back! With lower inflation, interest rates fall to 6%. Unfortunately, with so much capacity, the selling price of milk drops to $1.20. Starting from the "Base Case" which Financial Risk Factor had the greatest impact on profit, either positive or negative?

A. Selling price per gallon.

B. Cost of goods sold (owing to foreign currency)

C. Interest expense

D. None of the above

Answer 1

Scenario 1:

Answer - C. Both options provided.

Reason : Commodity price risk as selling price per gallon of milk rose by $0.05 to $1.55 per gallon.  Currency exchange rate risk as USD value fell by 10% against the Canadian dollar ($CAD) and the Mexican Peso (MXN) thereby raising the cost in USD when converted.

Scenario 2 :

Answer - A. Selling price per gallon.