Question

DeKalb, Inc. is a U.S. company that sells apparel in the U.S. and in New Zealand. It is due to receive NZ$10,000,000 in 3 months time from its New Zealand distributor. It also needs to pay NZ$5,000,000 in 3 months to its New Zealand wool supplier.

a. If there’s a 60% chance that NZ$1 will be equal $0.55 in 3 months, and a 40% chance that NZ$1 will be equal $0.45 in 3 months, then what is the range within which DeKalb cash flow will be, given the two possible exchange rate scenarios? What is the expected value of DeKalb’s net cash flow? Please explain your answer with appropriate calculations.

Answer 1

DeKalb Inc.'s cash flow will range between $2,250,000 and $2,750,000 depending on the exchange rate, with an expected value of $2,600,000.

Step-by-step explanation:

To determine the range within which DeKalb Inc.'s cash flow will be given the two possible exchange rate scenarios, we need to calculate the cash flows under each exchange rate scenario. The company will receive NZ$10,000,000 and will pay NZ$5,000,000 in 3 months.

If the exchange rate is 0.55 USD/NZD, DeKalb will receive $5,500,000 (NZ$10,000,000 * 0.55) and will pay $2,750,000 (NZ$5,000,000 * 0.55), resulting in a net cash flow of $2,750,000. If the exchange rate drops to 0.45 USD/NZD, the company will receive $4,500,000 (NZ$10,000,000 * 0.45) and will pay $2,250,000 (NZ$5,000,000 * 0.45), resulting in a net cash flow of $2,250,000. Thus, DeKalb's cash flow will range between $2,250,000 and $2,750,000.

The expected value of DeKalb's net cash flow can be calculated by weighting each potential cash flow by its probability of occurrence. There's a 60% chance that the net cash flow will be $2,750,000 and a 40% chance that it will be $2,250,000. The expected value of the net cash flow is therefore 0.6 * $2,750,000 + 0.4 * $2,250,000, which equals $2,600,000. This is the average expected net cash flow considering both possible exchange rate scenarios.