Question

9. Assume that Park Meadows Co. (a U.S. firm) knows that it will have cash inflows of $900,000 from domestic operations, cash inflows of 200,000 Swiss francs resulting from exports to Swiss operations, and cash outflows of 500,000 Swiss francs at the end of the year. Although the future value of the Swiss franc is uncertain, your best guess is that it will be worth $1.10 at the end of this year. a. What are the expected dollar cash flows of Park Meadows Co? b. Assume that Concord Co. (a U.S. firm) is in the same industry as Park Meadows Co. There is no political risk that could have any impact on the cash flows of either firm. Concord Co. knows that it will have cash inflows of $900,000 from domestic operations, cash inflows of 700,000 Swiss francs from exports to Swiss operations, and cash outflows of 800,000 Swiss francs at the end of the year. i. What are the expected dollar cash flows of Concord Co? ii. Is the valuation of the total cash flows of Concord Co. more uncertain or less uncertain than the total cash flows of Park Meadows Co.?

Answer 1

a. Park Meadows being a US firm, US dollars is the home currency and Swiss francs will be the foreign currency.

The cash flows being-

From domestic operations = $ 900,000

From Swiss opearations (In swiss francs) = Cash outflow 500,000 - Cash inflow 200,000

= Net cash outflow 300,000 swiss francs.

Cash outflow in dollars for swiss operations = 300,000 * 1.1

= $ 330,000.

Total expected Cash flow to Park Meadows = Cash inflow 900,000 - Cash outflow 330,000

= 570,000.

b.  

(i) Concord Co. being a US firm, US dollars is the home currency and Swiss francs will be the foreign currency.

The cash flows being-

From domestic operations = $ 900,000

From Swiss opearations (In swiss francs) = Cash outflow 800,000 - Cash inflow 700,000

= Net cash outflow 100,000 swiss francs.

Cash outflow in dollars for swiss operations = 100,000 * 1.1

= $ 110,000.

Total expected Cash flow to Concord Co. = Cash inflow 900,000 - Cash outflow 110,000

= 790,000.

b.

(ii) The uncertainity in the cash flows depends on the amount of cash flows exposed to the foreign currency. The company which has the more cash flows exposed to foreign currency, that company cash flows will be uncertain.

The question has the two companies Park Meadows Co. and Concord Co. which has the cash flows in swiss francs at the year end. The net cash flows is needed to be considered to arrive a decision on the uncertainity on cash flows.

The net cash flows for Park Meadows Co. in Swiss Francs = 300,000 Swiss francs - cash outflow

The net cash flows for Concord Co. in Swiss Francs = 100,000 Swiss francs - cash outflow

Based on the facts above, the Park Meadows have more net cash out flow than the Concord exposed to foreign currency. Changes in the foreign exchange rate will lead to more change in cash flow.

So, the cash flows of Concord Co. is less uncertain than the Park Meadows Co.